Building a new workshop is a significant investment and a major milestone for a growing business. However, for accountants and SMB owners, the costs associated with a construction project are handled very differently from day-to-day operating expenses. Unlike rent or utilities, you cannot simply deduct the entire cost of construction in the year you pay the bills.
The Internal Revenue Service (IRS) requires that these costs be capitalized and their value deducted over many years through depreciation. Understanding this process is essential for maintaining compliant books and accurately filing your business taxes.
The costs associated with building a new workshop are not treated as a current expense. Instead, they are considered a capital expenditure. This is because you are creating a long-term business asset—a building that will provide value for more than one year.
In your accounting system, the total cost of the construction project is recorded on the balance sheet as a fixed asset. The proper asset category is "Buildings" or, more specifically for tax purposes, "Nonresidential Real Property". The expense is then recognized incrementally over its useful life through annual depreciation deductions.
It is critical to distinguish construction costs from routine, deductible repairs. A repair simply keeps your property in good operating condition, while construction creates a new asset or permanently improves an existing one.
When you construct a building, you must capitalize all the direct and certain indirect costs associated with the project. This means the final asset value on your books isn't just the payment to a single contractor; it's the sum of all related costs, which may include:
A crucial rule is that the cost of the land is accounted for separately and cannot be depreciated. Your capitalized cost for the workshop should only include the expenses directly related to constructing the building itself.
The following are common examples of costs that must be capitalized as part of the workshop's basis:
You recover the capitalized cost of your new workshop through annual depreciation deductions. You begin to depreciate the property when it is "placed in service," meaning it is ready and available for its specific use.
Depreciation is calculated and reported on Form 4562, Depreciation and Amortization. The total depreciation amount for the year is then carried over and deducted on your business tax return. For a sole proprietor, this is reported on Schedule C (Form 1040), line 13.
For tax purposes, a newly constructed workshop is considered nonresidential real property and must be depreciated using the Modified Accelerated Cost Recovery System (MACRS) with the following parameters:
For a construction project, meticulous recordkeeping is essential. You must keep all documents that support the final capitalized basis of your workshop. This includes:
A construction project can generate hundreds or even thousands of individual invoices, receipts, and payments. Manually tracking every cost to accurately calculate the workshop's final basis is a massive undertaking and a significant compliance risk. Fyle provides a streamlined solution for managing these complex project costs.
Focus on building your business, and let Fyle help you build your books with confidence.