In accounting for assets under construction, you collect every cost directly tied to building a long-term asset in a temporary balance-sheet account (often labeled Construction in Progress or Assets Under Construction) and hold it there until the asset is substantially complete and ready for use. At that point the entire balance moves to a permanent fixed asset account, depreciation begins, and the holding account returns to zero. Classify a cost wrong and you either inflate the current period’s expenses or overstate the asset’s basis for years, so the sorting work at the front end carries weight well beyond the construction window.
Which Costs Go Into the Account
The sorting rule is simple to state: if a cost is directly tied to getting the asset built and ready for use, capitalize it. If it would exist whether or not you were building anything, expense it in the current period.
Costs that belong in the construction account include:
- Raw materials that become part of the structure, plus wages for construction crews and on-site supervisors.
- Payments to architects, engineers, surveyors, and attorneys handling zoning or title work.
- Building permits, environmental clearances, and similar government approvals.
- Testing and commissioning costs to run equipment through trial operations or verify that systems meet specifications.
- Site preparation like grading and drainage work.
Costs that must be expensed immediately include general corporate overhead unrelated to the project, routine maintenance on existing operational assets, and administrative costs that would be incurred whether or not the construction project existed.
Demolition and Site Clearing
When you buy property intending to tear down an existing building and construct something new, the demolition costs and the entire purchase price of the old building are capitalized to the land account, not the new building. That distinction matters because land is never depreciated. If you bought the property without any demolition plans and only later decided to tear the building down, the remaining book value of the demolished structure plus net demolition costs are recognized as a loss in the period of demolition, and none of that cost carries over to the replacement building.1eCFR. 26 CFR 1.165-3 Demolition of Buildings
Land Versus Building
Not every dollar spent during construction belongs in the building account. Utility systems, landscaping, parking lots, and fencing that serve the broader site rather than a specific building are land improvements, depreciated on their own schedule or, in some cases, treated as part of the land itself and not depreciated. Internal plumbing and electrical wiring are capitalized as part of the building. The deciding question is whether the improvement is physically attached to and primarily serves the building, or whether it supports the site as a whole.
When Capitalization Starts and Stops
Capitalization begins when three conditions are present at the same time: you’ve started spending money on the asset, activities to get it ready for use are underway, and interest costs are being incurred. Those qualifying activities are read broadly. Developing architectural plans, applying for permits, and conducting feasibility studies all count, not just physical construction.2FASB. Summary of Statement No. 34 – Capitalization of Interest Cost
Capitalization stops when the asset is substantially complete and ready for its intended use, even if you haven’t started using it yet. Substantially complete means the major construction work is done and the asset is in the condition and location needed for operations. Punch-list items and minor cosmetic finishing don’t justify continuing to capitalize.
Interruptions and Delays
If your company deliberately suspends substantially all construction activities, you must also suspend capitalization. Brief interruptions, delays caused by external forces like labor disputes or permitting holdups, and slowdowns that are inherent in any construction process don’t trigger a suspension. The reasoning is that normal interruptions are part of getting an asset ready for use, so carrying costs during those periods remain part of the asset’s total cost.3EY. Financial Reporting Developments: Real Estate Project Costs
Capitalizing Interest
When you borrow money to finance construction, the interest you pay during the building period isn’t simply expensed. Under GAAP, you’re required to capitalize a portion of that interest into the construction account when the effect is material. The concept is called “avoidable interest”: you capitalize only the interest cost you could have avoided if you hadn’t made the construction expenditures in the first place.2FASB. Summary of Statement No. 34 – Capitalization of Interest Cost
The calculation uses weighted-average accumulated expenditures (WAAE), the average amount tied up in the project through the period, with each expenditure weighted by how long it was outstanding. If you took out a loan specifically for the project, apply that loan’s rate to WAAE up to the amount of the specific borrowing. Any expenditures beyond that specific loan get multiplied by a weighted average of your other outstanding borrowing rates.2FASB. Summary of Statement No. 34 – Capitalization of Interest Cost
There is a ceiling: capitalized interest can never exceed the total interest cost your company actually incurred during the period. You’re reallocating real interest, not creating it. Interest capitalization follows the same start-and-stop rules as other construction costs.
Overhead, Property Taxes, and Insurance
Indirect costs require more judgment than direct construction spending. Only incremental overhead that exists because of the project belongs in the construction account. A project manager hired specifically for the build, temporary power at the construction site, and a project field office all qualify. Corporate accounting salaries, headquarters rent, and other fixed costs that would exist regardless of the project are period expenses.
Property taxes and insurance on the asset under construction follow the same capitalization window as interest. You capitalize them while activities necessary to get the property ready for use are actively in progress. If you’re holding undeveloped land for future construction but haven’t started any development activities, property taxes and insurance on that land are expensed as incurred. Once the asset is substantially complete, you stop capitalizing these carrying costs and begin expensing them.3EY. Financial Reporting Developments: Real Estate Project Costs
Internal-Use Software Projects
Major IT systems qualify as assets being produced, but software follows its own framework under ASC 350-40 rather than the general property, plant, and equipment rules. The development process splits into three stages, and only one allows capitalization.
- Preliminary project stage. All costs are expensed. This covers exploratory research, evaluating vendors, determining whether the technology can do what you need, and deciding whether to move forward.
- Application development stage. Costs are capitalized. This begins once management has authorized and committed funding to a project that will probably be completed. Coding, software configuration, installation of hardware, and testing fall here. Capitalization stops when the software is substantially complete and ready for use.
- Post-implementation stage. All costs are expensed. User training, ongoing maintenance, and post-go-live bug fixes are period costs.
The line between the preliminary and application development stages is a common audit issue because exploratory work blends into design. The clearest marker is formal management authorization and commitment of funding to a specific project scope.
Cloud computing arrangements add a layer. If you’re implementing a hosted solution where you control the software or have a contractual right to take possession of it, you apply the same three-stage framework. If you’re subscribing to a vendor’s hosted service without any right to the underlying software, implementation costs generally follow the same capitalization logic for the customer’s implementation activities, though the capitalized amounts are classified differently on the balance sheet.
Transferring the Completed Asset and Starting Depreciation
When the asset is substantially complete, you move the entire construction balance to the appropriate permanent fixed asset account with a journal entry that debits the fixed asset account (Buildings, Machinery, or whichever category applies) and credits the construction account, bringing it to zero. Depreciation begins at that point because the asset is ready for use, even if actual operations haven’t started yet.4BIA.gov. Assets Under Construction Accounting Management Handbook 27 IAM-15-H
At transfer, management must set the asset’s estimated useful life and residual value. These estimates drive depreciation for the life of the asset, so errors compound. Most companies default to straight-line depreciation for buildings, while equipment with heavier early-year usage might warrant an accelerated method like double-declining balance.
Component Depreciation
A building isn’t one monolithic asset. The structural shell, HVAC system, roof, elevators, and electrical systems all have different useful lives. Under GAAP, companies can elect to break the total cost into components and depreciate each on its own schedule. This is optional under U.S. GAAP (mandatory under IFRS), but many companies adopt it because replacing a roof in year 15 of a 40-year building creates cleaner accounting when the roof was tracked separately from the start.
When you componentize, allocate costs from contractor invoices where specific identification is possible. When exact cost breakdowns aren’t available, use relative fair values or another reasonable method like relative square footage for real estate.
Impairment and Project Abandonment
Assets under construction aren’t immune to impairment. If circumstances suggest the project’s carrying amount may not be recoverable, you test it. Common triggers include costs running significantly beyond the original budget, a shift in the business that eliminates the need for the asset, and a market downturn that undermines the project’s economic rationale.
The recoverability test compares the asset’s carrying amount to the undiscounted future cash flows it’s expected to generate. If the carrying amount exceeds those cash flows, you have an impairment, and you write the asset down to fair value. The difference hits the income statement as a loss in the current period.
When a project is permanently abandoned with no alternative use for what’s been built, the entire construction balance is written off as a loss. The journal entry debits an impairment loss account and credits the construction account for the full carrying amount. There is no gradual wind-down; once you’ve determined the asset will never provide future economic benefit, immediate recognition is required under ASC 360. Partial abandonment is harder. If parts of a project are salvageable or can be repurposed, write off only the portion with no future benefit and retain the remainder at its recoverable amount. Documentation matters here, particularly on significant projects where auditors will scrutinize the timing and completeness of the write-off.
Tax Treatment Under Section 263A
The IRS has its own capitalization rules under Section 263A, commonly called the Uniform Capitalization (UNICAP) rules, and they’re broader than GAAP in some respects. Any taxpayer that produces real or tangible personal property must capitalize both the direct costs and a proper share of indirect costs, including taxes allocable to the property.5Office of the Law Revision Counsel. 26 U.S. Code 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses
UNICAP casts a wider net for indirect costs than GAAP does. Pension contributions, certain employee benefits, and a broader range of administrative overhead must be capitalized for tax purposes even though they might be expensed under GAAP. This creates book-tax differences that need to be tracked and reconciled.
The tax rules for interest capitalization apply to what the regulations call “designated property,” and the thresholds differ from GAAP’s materiality standard. Interest must be capitalized for any real property produced by the taxpayer. For tangible personal property, the triggers are an estimated production period exceeding two years, or a production period exceeding one year combined with estimated production costs above $1,000,000.6eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
A de minimis exception applies to smaller projects: if the production period is 90 days or less and total production expenditures (excluding land cost and the basis of existing property used in production) don’t exceed $1,000,000 divided by the number of days in the production period, interest capitalization isn’t required.6eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
Balance Sheet Presentation and Disclosures
The construction account appears on the balance sheet as a non-current asset within property, plant, and equipment. Most companies list it as a separate line item or disclose it parenthetically, signaling that this investment isn’t yet generating revenue or being depreciated. Analysts use that visibility to assess capital deployment and future depreciation impacts.
When the completed asset transfers to a permanent fixed asset account, the entry is a reclassification between two asset accounts with no cash changing hands. It doesn’t flow through the income statement. On the cash flow statement, the original expenditures would have been reported as investing outflows when the cash was spent during construction. The transfer itself is a noncash activity that may require supplemental disclosure under ASC 230 but doesn’t create a new cash flow line.
For interest capitalization, the notes to the financial statements must disclose both the total interest cost incurred during the period and the portion that was capitalized, so users can see the full picture of borrowing costs and understand how much was shifted to the balance sheet rather than recognized as expense.