How to Make a Section 266 Election for Carrying Costs

To make a Section 266 election, attach a written statement to your original, timely filed federal income tax return that identifies the property involved and lists the specific carrying charges you are choosing to capitalize instead of deduct.¹ There is no IRS form for this. You draft the statement yourself, and the details you include (or leave out) determine whether the election holds up under examination.

What the Election Statement Must Contain

At a minimum, the statement needs to identify the property, name the specific charges you are capitalizing, and state the dollar amount for each.² A workable format reads along these lines: “The taxpayer elects, pursuant to IRC Section 266, to capitalize rather than deduct the following carrying costs incurred with respect to [property description] located at [address],” followed by an itemized breakdown.

Describe the property specifically enough that an examiner could identify it from your statement alone. Use a street address or legal description for real estate, or a serial number and description for equipment. A statement that references “all carrying charges on my properties” without saying which properties, which charges, or how much gives the IRS grounds to reject the election.

Choose Charges Item by Item

Section 266 gives you unusual flexibility. The regulation lets you specify “the item or items (whether with respect to the same project or to different projects)” you want to capitalize.¹ You can capitalize interest on a construction project but deduct the property taxes. You can capitalize taxes on one parcel and deduct them on another. Every choice needs to be spelled out. Blanket language does not work.

Interest Requires Tracing

If interest is one of the charges you are capitalizing, trace the loan proceeds to the property named in your statement. Under the allocation rules, debt follows where the borrowed money actually went, not what secures the loan.³ A mortgage recorded against Property A does not mean the interest relates to Property A if the proceeds were used to buy Property B. Keep records of disbursement dates, amounts, and which property received the funds.

Where and When to File It

The statement attaches to your original return for the year the charges were incurred.¹ For individuals that is Form 1040, corporations use Form 1120, and partnerships file with Form 1065. The filing deadline includes any valid extension. A six-month extension through Form 4868 (individuals) or Form 7004 (businesses) gives you the additional time to prepare and attach the statement.

The word “original” matters. An amended return filed after the due date, extensions included, generally will not work to make a first-time election without separate IRS relief.² This is where taxpayers most often lose the election. They realize after filing that capitalizing would have been the better call, but by then the window has closed.

Once the return is filed, make sure the capitalized amounts flow into the property’s basis on the relevant schedules. For depreciable property, the increased basis should appear on Form 4562 so future depreciation starts from the correct figure.

Confirm the Property and Charges Qualify

Only expenses that would otherwise be deductible somewhere on your return can be capitalized under Section 266. Costs that are not deductible in the first place do not become capitalizable through the election.

Eligible property falls into three categories: unimproved and unproductive real property, real property under development or construction, and personal property that has not yet been installed or placed in service.¹ The qualifying charges vary by category. For vacant land, they include property taxes, mortgage interest, and other holding costs. For a construction project, they include construction-loan interest, property taxes during the build, employment taxes on construction wages, and equipment storage. For personal property awaiting service, they include insurance, transportation, storage, and interest on the purchase debt.

A boundary worth flagging: once land becomes productive (rental income, active business use, a parking operation), the annual carrying charges on that year’s activity no longer qualify under the unproductive-property category. General overhead not tied to the specific property never qualifies.

How Long the Election Binds You

The answer depends on which category of property you elected for, and it changes whether you need to refile a statement each year.

Unproductive Real Property: Annual

For unimproved, unproductive real property, the election is made year by year. You decide each tax year whether to capitalize or deduct, and you are not locked into last year’s choice.¹ The catch: the election does not carry forward. If you want to capitalize again next year, you file a new statement with next year’s return. Skip the statement and you have effectively chosen to deduct.

Development and Personal Property: Binding Until Done

An election for property under development or personal property awaiting installation is binding for the whole project. Once you elect to capitalize a category of charges on a construction build, all similar charges incurred until the project is substantially complete or the asset is placed in service must also be capitalized.¹ Capitalizing interest in year one and then deducting it in years two and three of a three-year build is not permitted. Revoking a binding election mid-project requires a private letter ruling, which is rarely granted.

Records to Keep Behind the Statement

The election statement is the visible piece, but the paperwork behind it has to support every number. Hold on to invoices, property tax bills, loan statements, payroll records for construction workers, and storage receipts for each capitalized amount. Each charge you capitalize must have been legitimately deductible in the first place, so your records need to establish both the amount and the underlying deductibility.

For any capitalized interest, keep the interest-tracing documentation described above: disbursement dates, amounts, and which property or project received the funds.³ This is what an examiner will ask for if the election is questioned.

If You Already Filed Without the Statement

Two paths exist, and the cost difference between them is substantial.

Automatic 12-Month Extension

Treasury Regulation 301.9100-2 grants automatic extensions for certain elections that were due with the return. The mechanics: file an amended return within 12 months of the original due date (including extensions), attach the election statement, and write “FILED PURSUANT TO § 301.9100-2” at the top.⁴ There is no user fee and no ruling request. Section 266 is not explicitly listed among the elections named for this automatic relief, so whether it qualifies under the regulation’s general language is a question to raise with your tax advisor based on your facts.

Private Letter Ruling Under 301.9100-3

If the automatic route does not apply or the 12-month window has already closed, you request a private letter ruling under Regulation 301.9100-3. You have to show two things: that you acted reasonably and in good faith in missing the election, and that granting relief will not prejudice the government’s interests.⁵ Reliance on a qualified tax professional who did not advise you about the election is one of the recognized reasonable-cause scenarios. Prejudice generally exists if the late election would produce a lower aggregate tax bill than a timely one would have, which prevents hindsight cherry-picking.

The IRS user fee for a 301.9100-3 ruling request is $14,500 for requests received after January 29, 2026.⁶ Professional fees come on top of that. The IRS has granted this relief for Section 266 in published private letter rulings, so the door is open, but the price of walking through it is real.²

Mistakes That Void the Election

Not filing the statement with the original return is the most common failure. Preparers and taxpayers decide to capitalize after the fact, attach the statement to an amended return, and assume it counts. Without separate relief, it does not.

Vague documentation is next. A statement that identifies neither the property nor the specific charges nor the amounts invites rejection. Every property, every charge, every dollar goes on the page.

Capitalizing charges on productive property is another recurring problem. If land is already generating rental income or is in active business use, its annual carrying charges do not qualify under the unproductive-property category. Development or construction activity moves the property into a different category, and only charges incurred during the development period qualify there.

Interest tracing failures round out the list. If you capitalize interest on a loan whose proceeds went to a property other than the one named in your election statement, the mismatch will not survive examination. The interest follows the money, not the collateral.³

1
eCFR. 26 CFR 1.266-1 – Taxes and Carrying Charges Chargeable to Capital Account and Treated as Capital Items
2
Internal Revenue Service. PLR-118212-23 – Request for Extension of Time to Make the Election Under Section 266 to Capitalize Interest to Personal Property
3
eCFR. 26 CFR 1.163-8T – Allocation of Interest Expense Among Expenditures (Temporary)
4
eCFR. 26 CFR 301.9100-2 – Automatic Extensions
5
eCFR. 26 CFR 301.9100-3 – Other Extensions
6
Internal Revenue Service. Internal Revenue Bulletin 2026-01