26 U.S.C. § 263A — Capitalization and inclusion in inventory costs of certain expenses

(a) Nondeductibility of certain costs: For property this section covers, you can't currently deduct certain costs. If the property is inventory in your hands, those costs get added to inventory cost; for any other property, they get capitalized (added to its basis). The costs covered are the property's direct costs, plus its fair share of indirect costs (including taxes) that are allocable to it — but only costs you could otherwise count toward taxable income for that year. (b) Property covered: Unless this section says otherwise, it applies to real or tangible personal property you produce, and to real or personal property described in section 1221(a)(1) that you acquire for resale. "Tangible personal property" for this purpose includes a film, sound recording, video tape, book, or similar property. (c) General exceptions: This section does not apply to property you produce for your own personal use outside a trade, business, or for-profit activity; to amounts deductible under section 174 or 174A (research and experimental costs); to costs deductible under section 167(h), 179B, 263(c), 263(i), 291(b)(2), 616, or 617 (certain mineral and well development costs); to property you produce under a long-term contract; to trees you raise, harvest, or grow — other than certain trees described in subsection (e)(4)(B) — and the land under them. Paragraphs (2) and (3) of this subsection still apply to amounts deductible under section 59(e) for the qualified expenditures described there. This section also does not apply to amounts deductible under section 168(k)(5), covering certain fruit- and nut-bearing plants. (d) Exception for farming businesses: This section doesn't apply to any animal, or to any plant with a preproductive period of 2 years or less, that you produce in a farming business — unless you're a corporation, partnership, or tax shelter required to use the accrual accounting method under section 447 or 448(a)(3), in which case the exception does not apply. If plants bearing an edible crop were lost or damaged while in your hands by freezing, disease, drought, pests, or another casualty, this section doesn't apply to your costs of replanting the same type of crop, on the same land or other land of the same acreage in the United States. This also covers replanting costs paid by someone else who holds part of the ownership and materially participates in planting, maintaining, or developing the plants, as long as the original taxpayer keeps an equity interest of more than 50% throughout that tax year. For citrus plants specifically, a temporary, broader version of this rule — ending 10 years after the Tax Cuts and Jobs Act's enactment — also covers a person who bought the taxpayer's entire interest in the damaged land and replants there. A taxpayer may instead elect for this whole section not to apply to any plant produced in their farming business. Corporations, partnerships, or tax shelters required to use the accrual method may not make this election. For citrus and almond groves, the election doesn't apply to costs from planting, cultivating, maintaining, or developing the grove until the close of the 4th tax year after planting (each year's plantings treated separately). Unless the Secretary allows otherwise, this election can only be made for the taxpayer's first tax year beginning after December 31, 1986 in which the taxpayer is in a farming business, and once made it can be revoked only with the Secretary's consent. (e) Definitions and rules for subsection (d): If a taxpayer elected out under (d)(3), any plant that would otherwise have had costs capitalized is treated as "section 1245 property" when disposed of, and the amount that would have been capitalized (the "recapture amount") is treated as a depreciation deduction for recapture purposes. If the taxpayer (or a related person) makes the (d)(3) election, the alternative (slower) depreciation method under section 168(g)(2) applies to all the taxpayer's farming-business property placed in service while the election is in effect. "Related person" means the taxpayer and family members; a corporation in which the taxpayer or family owns 50% or more of the stock; another corporation in the same controlled group; or a partnership in which the taxpayer or family owns 50% or more of the interests. "Family" means the taxpayer, the taxpayer's spouse, and their children under 18. "Preproductive period" means, for a plant with more than one crop or yield, the time before its first marketable crop; for any other plant, the time before it's reasonably expected to be disposed of (using the taxpayer's own farm supply counts as disposal). For a plant commonly grown in commercial quantities in the U.S., this period is based on a nationwide weighted average. "Farming business" means the trade or business of farming, including running a nursery or sod farm, and raising or harvesting trees bearing fruit, nuts, or other crops, or ornamental trees — except that an evergreen tree cut down after being more than 6 years old is not treated as ornamental. The Secretary must issue regulations letting taxpayers use reasonable inventory valuation methods to compute the amount required to be capitalized for any plant under subsection (a). (f) Special interest-allocation rules: Capitalized interest under this section applies only to interest paid or incurred during the "production period" for property described in subsection (b)(1) that has a long useful life, an estimated production period exceeding 2 years, or an estimated production period exceeding 1 year and a cost exceeding $1,000,000. To figure the interest required to be capitalized: interest on debt directly tied to producing the property is assigned to it, and interest on other debt is assigned to the extent the taxpayer's interest costs could have been reduced had the production expenditures not been incurred. This doesn't apply to qualified residence interest under section 163(h). For flow-through entities, this rule is applied first at the entity level, then at the beneficiary level, except as regulations provide. This subsection also applies to interest on debt allocable to property used to produce other covered property, to the extent that interest is allocable to the produced property. The "production period" does not include the aging period for beer (as defined in section 5052(a)), wine (as described in section 5041(a)), or distilled spirits (as defined in section 5002(a)(8)) — except spirits unfit for beverage use. Property has a "long useful life" if it is real property, or has a class life of 20 years or more. "Production period" runs from when production begins until the property is ready to be placed in service or held for sale (subject to the aging exception). "Production expenditures" are the costs required to be capitalized under subsection (a) with respect to the property, whether or not incurred during the production period. (g) Production: "Produce" includes construct, build, install, manufacture, develop, or improve. A taxpayer is treated as producing property that is produced for the taxpayer under a contract, but only costs the taxpayer actually paid or incurred count toward applying subsection (a). (h) Exemption for freelance authors, photographers, and artists: This section does not require capitalizing a "qualified creative expense" — an expense paid or incurred by an individual in their own trade or business (not as an employee) as a writer, photographer, or artist, that would be deductible for the year without this section. This exemption excludes expenses related to printing, photographic plates, motion picture films, video tapes, or similar items. "Writer" means an individual whose personal efforts create, or may reasonably be expected to create, a literary manuscript, musical composition (including words), or dance score. "Photographer" means an individual whose personal efforts create, or may reasonably be expected to create, a photograph, negative, or transparency. "Artist" means an individual whose personal efforts create, or may reasonably be expected to create, a picture, painting, sculpture, statue, etching, drawing, cartoon, graphic design, or original print edition, judged by the originality and uniqueness of the item and whether its aesthetic value predominates over its utilitarian value. This subsection also applies to a corporation's related expenses, in the same way as if incurred directly by the individual, if substantially all the corporation's stock is owned by a qualified employee-owner (and family) and the corporation's principal activity is performing personal services tied to that employee-owner's own creative work, substantially performed by the employee-owner. (i) Exemption for certain small businesses: This section does not apply to a taxpayer (other than a tax shelter barred from cash-method accounting under section 448(a)(3)) for any year the taxpayer meets the gross receipts test of section 448(c). For a taxpayer that is not a corporation or partnership, that test is applied as if each of the taxpayer's trades or businesses were a corporation or partnership. Any accounting method change made because of this exemption is treated, for section 481 purposes, as initiated by the taxpayer and made with the Secretary's consent. (j) Regulations: The Secretary must prescribe regulations necessary to carry out this section, including regulations to prevent using related parties, pass-through entities, or intermediaries to avoid this section, and regulations providing simplified procedures for applying this section to property described in subsection (b)(2).