Construction in Progress accounting is the method of pooling every cost of building a long-term asset in a temporary balance sheet account until the asset is ready for use, then transferring the full balance to a permanent fixed asset account where depreciation begins. The CIP account lives inside property, plant, and equipment as a non-current asset, but nothing in it is depreciated while it sits there. That is the whole point: construction spending stays off the income statement until the asset actually starts doing its job, and the accumulated total becomes the depreciable basis the day it moves out.
Done well, CIP gives you a clean depreciable basis, defensible tax deductions, and financial statements that reflect what you actually built. Done loosely, it becomes a dumping ground that auditors unwind one invoice at a time.
What Costs Go Into CIP
Any cost necessary to bring the asset to its intended use and location is a candidate for capitalization. Those costs fall into three groups.
Direct Costs
Direct costs are the ones you can point at. Materials like steel, concrete, lumber, and permanently installed equipment. Labor: wages, payroll taxes, and benefits for workers whose time is on the project. Track labor through time sheets or dedicated project codes. Blended labor that splits between construction and routine operations is where allocation disputes start.
Indirect Costs
Indirect costs support the construction without becoming part of the physical structure. Architectural and engineering fees, building permits, project-specific legal costs, and site preparation all qualify. Overhead like utilities for the construction site or temporary security has to be allocated using a consistent method, typically based on direct labor hours or material costs. Pick a method early and keep it for the life of the project.
Capitalized Interest
Borrowing costs during construction get capitalized rather than expensed when the asset qualifies. For tax, Section 263A requires interest capitalization on property you produce that has a long useful life (real property, or property with a class life of 20 years or more), an estimated production period exceeding two years, or a production period exceeding one year with costs above $1,000,000.1Office of the Law Revision Counsel. 26 USC 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses The IRS applies the “avoided cost method,” which asks how much interest you could theoretically have avoided had you used construction spending to pay down debt instead.2eCFR. 26 CFR 1.263A-9 – The Avoided Cost Method
Under GAAP, the capitalized amount is capped at actual interest incurred for the period. You determine it by applying a capitalization rate to the weighted-average accumulated expenditures on the asset. If you borrowed specifically for the project, use that loan’s rate first; expenditures above the specific borrowing get a blended rate from your other outstanding debt. Capitalization starts once spending has begun and construction activities are underway, and ends when the asset is substantially complete and ready for its intended use.
One boundary worth knowing: small businesses that meet the gross receipts test under Section 448(c), generally those averaging $31 million or less in annual gross receipts (adjusted annually for inflation), are exempt from Section 263A capitalization entirely, including the interest rules.3eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
What to Keep Out of CIP
The most common CIP mistake is capitalizing something that should have been expensed. The IRS tangible property regulations draw the line with three tests, and work must be capitalized as an improvement if it meets any one of them:4eCFR. 26 CFR 1.263(a)-3 – Amounts Paid to Improve Tangible Property
- Betterment: the work fixes a pre-existing defect, adds something physically new, or materially increases the property’s productivity, efficiency, or output.
- Restoration: the work replaces a major component or substantial structural part, returns non-functional property to working condition, or rebuilds it to like-new condition after its class life has expired.
- Adaptation: the work converts the property to a new or different use from what it was designed for.
Replacing a handful of damaged shingles after a storm is a repair. Stripping and replacing the entire roofing system with upgraded material is a betterment. The scope and effect of the work matter more than the dollar amount.
Two safe harbors keep smaller items out of CIP cleanly. The de minimis safe harbor lets you expense amounts up to $5,000 per invoice or item if you have an applicable financial statement, or $2,500 without one.5Internal Revenue Service. Tangible Property Regulations – Frequently Asked Questions You need a written accounting policy in place at the start of the year and must attach an election statement to your return. The routine maintenance safe harbor covers recurring activities you reasonably expect to perform more than once during the asset’s class life: inspections, cleaning, testing, minor part replacements. These are operating expenses and should never land in CIP.
Running the CIP Ledger
A CIP account that isn’t tightly managed becomes an archaeological dig at transfer time. The controls you set up before the first invoice hits the ledger save enormous pain later.
Project Codes
Every capital project needs its own unique code in your accounting system, and every purchase order, invoice, and labor entry must reference it. If you’re running multiple projects at once, sloppy coding guarantees cross-contamination, and auditors notice quickly.
Documentation
Every cost in CIP needs a paper trail: vendor invoices, executed contracts, time sheets, internal allocation memos. For capitalized interest, retain the loan agreements, payment schedules, and the worksheets showing weighted-average accumulated expenditures. Auditors don’t just want to see that you spent $3 million on a building. They want the invoices, the approval chain, and the logic connecting each cost to the asset.
Periodic Reviews
Run a review of every cost sitting in CIP on a regular cadence. Apply the betterment, restoration, and adaptation tests to confirm each expenditure genuinely qualifies.4eCFR. 26 CFR 1.263(a)-3 – Amounts Paid to Improve Tangible Property Routine maintenance that slipped in through a miscoded invoice needs to be reclassified out before the account is closed. Catching errors during construction is far easier than unwinding them after the asset is in service.
Closing CIP and Transferring to a Fixed Asset
CIP is temporary. Once construction is done, the balance transfers to a permanent fixed asset account, and that transfer establishes the depreciable basis.
The In-Service Date
The in-service date is the single most consequential judgment in the CIP process. For IRS purposes, property is placed in service when it is ready and available for a specific use, whether or not you’ve actually started using it.6Internal Revenue Service. Publication 946 – How To Depreciate Property A completed warehouse that sits empty for two months while you hire staff is already in service the day it’s ready to store inventory.
That date triggers two things at once: interest capitalization stops, and depreciation starts. Push the date too early and you lose legitimate capitalizable costs. Push it too late and you delay depreciation deductions you’re entitled to, while overcapitalizing interest. Support whatever date you choose with objective evidence: a certificate of occupancy, a final inspection sign-off, a documented operational readiness assessment.
The Journal Entry
The transfer is clean. Debit the permanent fixed asset account (Buildings, Machinery and Equipment, or similar) for the total accumulated cost, and credit CIP for the same amount. If you accumulated $5,000,000 in CIP for a new manufacturing facility, debit Buildings for $5,000,000 and credit Construction in Progress for $5,000,000. The CIP balance goes to zero. The building now lives in your fixed asset register at its full historical cost.
Depreciation After Transfer
The moment CIP becomes a fixed asset, two separate depreciation stories begin: one for tax, one for book. They rarely produce the same annual number.
MACRS for Tax
Most business property is depreciated under the Modified Accelerated Cost Recovery System. MACRS treats salvage value as zero, so you depreciate the full basis.7Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System Recovery periods depend on the asset class:
- 5-year property: computers, office machinery, automobiles, light trucks.
- 7-year property: office furniture and equipment, and any property without an assigned class life.
- 15-year property: land improvements like sidewalks, parking lots, and fencing.
- 27.5 years: residential rental buildings.
- 39 years: nonresidential real property (commercial buildings, warehouses, factories).
The default convention for personal property is the half-year convention, which treats the asset as placed in service at the midpoint of the tax year. If more than 40% of your total personal property additions for the year are placed in service in the last three months, the mid-quarter convention takes over, which can meaningfully reduce the first-year deduction. Real property always uses the mid-month convention.7Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
Bonus Depreciation and Section 179
For qualifying property placed in service after January 19, 2025, 100% bonus depreciation has been permanently restored. You can deduct the entire cost of eligible personal property, generally not buildings, in the first year.8Internal Revenue Service. Notice 2026-11 – Interim Guidance on Additional First Year Depreciation Deduction That is a dramatic change from the phase-down in effect through early 2025, and it makes the in-service date for large equipment projects a front-line planning decision.
Section 179 is a separate election to expense qualifying property in the year it’s placed in service, up to $2,560,000 for tax years beginning in 2026, with a phase-out starting at $4,090,000 in total qualifying property. Section 179 covers a broader range of property than bonus depreciation in some cases, including certain improvements to the interior of nonresidential buildings. The two provisions interact, so mapping out which assets use which deduction is worth the planning time.
Book Depreciation Under GAAP
Financial reporting gives management more discretion. You estimate a useful life based on physical wear, technological obsolescence, and any legal or contractual limits. You also estimate salvage value, the amount you’d expect to receive when the asset is retired. The depreciable basis for book purposes is capitalized cost minus salvage value, which is one reason book and tax depreciation diverge from day one.
Straight-line is the most common method for long-lived property; it spreads an equal charge across every period. A $10 million building with a 40-year useful life and $500,000 salvage value depreciates at $237,500 a year. Accelerated methods like double-declining balance front-load the deduction into early years and suit assets that lose value quickly after installation.
For complex assets, component depreciation breaks the capitalized total into major pieces (the structural shell, the roof, HVAC, elevators, electrical) and gives each its own useful life. It’s more work at setup, but it matches costs to economic reality instead of pretending every part of a building wears out at the same rate. The same thinking supports a cost segregation study on the tax side, which can reclassify building components into shorter MACRS recovery periods.
When a Project Doesn’t Finish
Not every construction project reaches the end. Markets shift, permits fall through, costs overrun. The costs sitting in CIP still have to go somewhere.
Abandonment Losses
If you permanently abandon a project before completion, the accumulated CIP costs become deductible as an ordinary loss under Section 165.9Office of the Law Revision Counsel. 26 USC 165 – Losses The key word is permanently. The IRS wants clear evidence that you’ve discarded the project with no intention of recovering the costs: a board resolution, a formal written decision to halt, documented strategy changes. If the abandonment is ambiguous or could be characterized as a sale or exchange, the loss may be reclassified as a capital loss, which can only offset capital gains.
The deductible amount includes everything accumulated in CIP up to abandonment: land preparation, design fees, engineering, materials, labor. The entry reverses the CIP balance into a loss account on the income statement.
Impairment
Even without abandonment, GAAP requires impairment testing whenever circumstances suggest the carrying amount may not be recoverable. Cost overruns are an explicit trigger: if accumulated costs significantly exceed the original budget, that signals evaluation. Other triggers include a significant drop in the expected market value of the completed asset, adverse changes in the business climate, or a current expectation that the asset will be disposed of well before its estimated useful life. The test compares the carrying amount to expected future cash flows. If carrying amount exceeds those cash flows, write the asset down to fair value and recognize the difference as a loss.