Real Estate Development Costs: Capitalize or Expense?

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In the real estate development industry the question of capitalization as always been a tricky subject. Many questions come up such as what expenses get capitalized, when do these items get capitalized, and what items can be expensed.  In this article we hope to provide a basic understanding of the concepts of capitalizing certain carrying costs.

During the development of a project, the developer will incur certain carrying costs related to the property.  Many costs can be considered carrying costs, but typically these include property taxes, insurance and interest.  Generally, these types of costs are considered period costs that are expensed as incurred, but during development, these costs must be accumulated as part of the cost of the asset being developed.

The basic rule related to carrying costs is that they should be capitalized as part of the cost of the asset being developed, and not expensed, during the capitalization period.  The capitalization period has been defined as the period in which the property is “undergoing activities necessary to get it ready for its intended use”.

The term activities has been construed broadly, and encompasses more than just physical construction, but includes all steps necessary to prepare the asset for its intended use, such as developing plans or obtaining permits before construction.

During development, projects may experience interruptions.  Generally, the capitalization period should continue, and carrying costs should be capitalized during brief interruptions.  However, if the entity suspends substantially all activities related to the development of the asset, capitalization of carrying costs should cease.

The capitalization period ends when the asset is substantially complete and ready for its intended use.  The end of the capitalization period generally coincides with the ceasing of all development activities, physical completion of the project or obtaining of a certification of completion or certificate of occupancy.

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