No, you do not depreciate construction in progress. Federal tax law only allows depreciation on property that has been placed in service, and an asset still being built fails that test by definition. Costs accumulate in a temporary account, commonly called Construction in Progress or CIP, until the asset is ready for its intended use. Only then does it move onto a depreciation schedule and your tax recovery begin.
Why Placed-in-Service Is the Gating Test
The whole question turns on a single concept. Under IRC Sections 167 and 168, depreciation is available only for tangible property that has been placed in service in your trade or business or for the production of income.1Office of the Law Revision Counsel. 26 USC 167 – Depreciation The IRS defines “placed in service” as the point when property is “ready and available for a specific use,” even if you haven’t started using it yet.2Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
The standard is functional readiness, not actual use. A completed warehouse sitting empty while you look for tenants is placed in service, because it is ready and available for its purpose. A factory that is structurally finished but missing the specialized equipment it was built to house is not, because it cannot yet perform its intended function. A building still under construction sits firmly on the wrong side of that line.
Document the exact placed-in-service date and be prepared to defend it. A certificate of occupancy, a final inspection report, or a formal sign-off from a project manager all serve as evidence. That date drives every year of the depreciation schedule that follows.
What You Do With Costs While the Project Is in CIP
While an asset sits in CIP, the associated costs are not current deductions. IRC Section 263A requires you to capitalize both direct and indirect costs into the asset’s basis.3Office of the Law Revision Counsel. 26 USC 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses The accumulated total becomes the basis you eventually depreciate.
Direct costs are the obvious ones: materials such as steel, concrete, and lumber, plus wages and benefits for employees physically working on the build. Indirect costs are where mistakes happen. Equipment rental, utilities consumed at the job site, insurance carried during construction, and allocable administrative overhead all get added to CIP rather than expensed in the year paid.
Construction Loan Interest
Interest on construction borrowing follows the same logic. Interest paid during the production period must be capitalized rather than deducted currently when the property has an estimated production period exceeding two years, or exceeds one year with costs above $1,000,000.3Office of the Law Revision Counsel. 26 USC 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses The production period runs from the date construction begins through the date the property is ready to be placed in service. Most significant commercial projects clear these thresholds easily.
The De Minimis Safe Harbor
Not every small purchase during construction has to be capitalized. The IRS allows a de minimis safe harbor election that lets you expense low-cost items instead of adding them to CIP. If your business has an applicable financial statement, the limit is $5,000 per invoice. Without one, the limit is $2,500 per invoice.4Internal Revenue Service. Tangible Property Regulations – Frequently Asked Questions The election is made annually.
What Happens When the Asset Is Placed in Service
Once the asset is placed in service, you reclassify the CIP balance to the appropriate fixed asset account, closing the temporary account and establishing the starting point for recovery under the Modified Accelerated Cost Recovery System (MACRS). The total transferred from CIP, minus any land cost, becomes the unadjusted basis for calculating annual depreciation.2Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
Carve Out the Land
Land is never depreciable, because it doesn’t wear out or become obsolete.2Internal Revenue Service. Publication 946 (2025), How To Depreciate Property If you bought the land and built on it, you have to separate the land cost from the building cost before starting depreciation. Only the building portion goes into your depreciable basis. Allocation typically follows the purchase contract when it splits land and building values, and otherwise uses relative fair market values from an appraisal or the local property tax assessment. Overlooking this step inflates your basis and creates an overstatement the IRS can easily catch.
Recovery Periods and Conventions
MACRS assigns each asset a class life. Nonresidential real property (commercial buildings, warehouses, factories) is 39-year property; residential rental buildings are 27.5-year property; land improvements such as fences, parking lots, and sidewalks are 15-year; office furniture and general equipment fall in the 5- or 7-year range.
The convention determines your first-year and final-year deductions. Real property, both 27.5-year and 39-year, uses the mid-month convention, treating the asset as placed in service at the midpoint of the month it actually went into service.2Internal Revenue Service. Publication 946 (2025), How To Depreciate Property Personal property generally uses the half-year convention, unless more than 40% of your personal property for the year is placed in service in the last quarter, in which case the mid-quarter convention applies instead. Applying the wrong convention throws off the entire schedule.
When Parts of a Project Finish at Different Times
A project doesn’t have to finish all at once. If a 100-unit complex has 30 units ready in January, 50 more in July, and the final 20 the following year, each group is placed in service on the date it becomes ready and available, not the date the whole project ends.5Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets Each portion starts its own depreciation schedule from its respective placed-in-service date. Additions and later improvements are treated the same way: a new wing added years after the original building has its own recovery period beginning when the addition itself is placed in service.6Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System Lumping everything together and waiting for full completion delays deductions you could be taking already.
Accelerating the Deduction Once Depreciation Starts
For assets placed in service in 2026, the recovery picture has changed. The One, Big, Beautiful Bill permanently reinstated 100% bonus depreciation for qualified property acquired after January 19, 2025.7Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One, Big, Beautiful Bill When a CIP asset transfers to its fixed asset account, you may be able to deduct the entire cost of qualifying components in the year placed in service.
Bonus depreciation applies to most tangible personal property with a recovery period of 20 years or less. It does not apply to buildings themselves, but building components reclassified through a cost segregation study can qualify.
Section 179 offers a second path. For tax years beginning in 2026, the expensing limit is $2,560,000, phasing out once qualifying property placed in service exceeds $4,090,000. Section 179 can apply to certain qualified real property improvements, including roofs, HVAC systems, fire protection, and security systems, in addition to personal property. Unlike bonus depreciation, the Section 179 deduction is capped at your business’s taxable income for the year and cannot create or increase a net operating loss.
Cost Segregation on a Newly Built Property
The default treatment for a newly constructed building puts the whole structure on a 39-year or 27.5-year straight-line schedule. A cost segregation study breaks the building apart and reclassifies certain components into 5-, 7-, or 15-year property that qualifies for accelerated depreciation and bonus depreciation.8Internal Revenue Service. Cost Segregation Audit Technique Guide The reclassified items are often carpeting, decorative lighting, removable partitions, specialized electrical circuits feeding equipment, and dedicated plumbing for non-structural purposes.
With 100% bonus depreciation available again for 2026, cost segregation is worth more than it has been in years. Every dollar shifted from 39-year property to 5-year or 7-year property can now be deducted entirely in the year the building is placed in service. The study requires IRS consent as a change in accounting method, so it works best when planned before or at the time of placing the asset in service, not as a later correction.
If the Project Is Abandoned Before Completion
Not every project reaches completion, and abandonment is a situation the depreciation rules don’t cover, so it’s worth flagging. If you permanently abandon a project, the asset never gets placed in service and never gets depreciated. IRC Section 165 allows a deduction for the loss instead, measured by the adjusted basis of the abandoned property, which is essentially the accumulated CIP balance.9Office of the Law Revision Counsel. 26 USC 165 – Losses
The word “permanently” carries weight. A pause with the intent to resume is not abandonment and does not trigger the loss deduction. You need a definitive, identifiable event: demolishing the partial structure, selling the site, or a documented management decision to walk away. Keep written records of the decision and the reasoning. Without that evidence, the IRS will treat the CIP balance as still alive and deny the deduction.
Penalties for Depreciating Too Early
Claiming depreciation on an asset still sitting in CIP creates an underpayment, and the IRS applies accuracy-related penalties to the shortfall. The standard penalty is 20% of the underpayment. When the error involves a gross valuation misstatement, overstating basis or the deduction by a large enough margin, the penalty rises to 40%.10Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
The IRS will also disallow the deductions for every affected year and recalculate your tax liability. You’ll owe back taxes plus interest running from the original due date. On a large project, the combined exposure of back tax, interest, and penalty adds up quickly. Solid documentation of the placed-in-service date is the simplest protection against that outcome.