{"id":12199,"date":"2019-01-09T09:26:04","date_gmt":"2019-01-09T14:26:04","guid":{"rendered":"https:\/\/foundationsoft.com\/?p=12199"},"modified":"2025-06-13T15:48:47","modified_gmt":"2025-06-13T19:48:47","slug":"capitalize-vs-expense","status":"publish","type":"post","link":"https:\/\/www.foundationsoft.com\/learn\/capitalize-vs-expense\/","title":{"rendered":"When to Capitalize vs. Expense Costs on a Construction Project"},"content":{"rendered":"\n<div class=\"wp-block-presto-player-reusable-edit\"><!--presto-player:video_id=33--><figure class=\"wp-block-video presto-block-video  presto-provider-youtube\" style=\"--plyr-color-main: var(--presto-player-highlight-color, #f8c01b); --presto-player-logo-width: 150px; \">\n\t<presto-player 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06:36:48&quot;,&quot;deleted_at&quot;:&quot;&quot;,&quot;show_time_elapsed&quot;:false}'\n\t\tbranding='{&quot;logo&quot;:&quot;&quot;,&quot;color&quot;:&quot;#f8c01b&quot;,&quot;logo_width&quot;:150,&quot;player_css&quot;:&quot;&quot;}'\n\t\tchapters='[]'\n\t\toverlays='[]'\n\t\ttracks='[]'\n\t\tblock-attributes='{&quot;playsInline&quot;:true,&quot;id&quot;:33,&quot;src&quot;:&quot;https:\\\/\\\/www.youtube.com\\\/watch?v=MIhccNEDNZo&quot;,&quot;preset&quot;:1,&quot;video_id&quot;:&quot;MIhccNEDNZo&quot;,&quot;visibility&quot;:&quot;public&quot;,&quot;color&quot;:&quot;#00b3ff&quot;,&quot;mutedPreview&quot;:{&quot;enabled&quot;:false,&quot;captions&quot;:false},&quot;mutedOverlay&quot;:{&quot;enabled&quot;:false,&quot;src&quot;:&quot;&quot;,&quot;width&quot;:200,&quot;focalPoint&quot;:{&quot;x&quot;:0.5,&quot;y&quot;:0.5}},&quot;mutedOverlayType&quot;:&quot;text&quot;,&quot;mutedOverlayText&quot;:&quot;Click to play&quot;,&quot;mutedOverlayImageWidth&quot;:200,&quot;chapters&quot;:[],&quot;overlays&quot;:[],&quot;tracks&quot;:[],&quot;openPopupId&quot;:&quot;&quot;,&quot;title&quot;:&quot;What It Means to Capitalize vs. Expense Construction Costs&quot;}'\n\t\tanalytics=''\n\t\tautomations\t\tprovider='youtube'\n\t\t\t\tid=\"presto-player-1\"\n\t\tsrc=\"\/\/www.youtube.com\/embed\/MIhccNEDNZo?iv_load_policy=3&amp;modestbranding=1&amp;playinline=1&amp;showinfo=0&amp;rel=0&amp;enablejsapi=1\"\n\t\tmedia-title=\"What It Means to Capitalize vs. Expense Construction Costs\"\n\t\tcss=\"\"\n\t\tclass=\"presto-video-id-33 presto-preset-id-1 skin-modern\"\n\t\tskin=\"modern\" \n\t\ticon-url=\"https:\/\/www.foundationsoft.com\/wp-content\/plugins\/presto-player\/img\/sprite.svg\" \n\t\tpreload=\"\" \n\t\tposter=\"\"\n\t\tyoutube=\"{&quot;noCookie&quot;:false,&quot;channelId&quot;:&quot;&quot;,&quot;show_count&quot;:false}\"\n\t\tprovider-video-id=\"MIhccNEDNZo\"\n\t\tvideo-id=\"33\"\n\t\t\t\tplaysinline \n\t\t\t\t>\n\t\t\n    <div class=\"presto-iframe-fallback-container\">\n        <iframe style=\"width: 100%\" title=\"Youtube Video\" class=\"presto-fallback-iframe\" id=\"presto-iframe-fallback-1\" data-src=\"https:\/\/www.youtube.com\/embed\/MIhccNEDNZo?iv_load_policy=3&amp;modestbranding=1&amp;playsinline=1&amp;showinfo=0&amp;rel=0&amp;enablejsapi=1\" allowfullscreen allowtransparency allow=\"autoplay\"><\/iframe>\n    <\/div>\n\n\t<\/presto-player>\n<\/figure><\/div>\n\n<div class=\"clear\"><\/div>\n<div class=\"gdlr-space\" style=\"margin-top: 20px;\"><\/div>\n<p class=\"PlaygroundEditorTheme__paragraph\" dir=\"ltr\"><strong>Construction costs are capitalized<\/strong> when they create long-term value and meet two criteria: the expense generates future revenue and provides benefits beyond one fiscal period.<\/p>\n<p class=\"PlaygroundEditorTheme__paragraph\" dir=\"ltr\">Direct costs like materials and labor, indirect costs like permits and supervision, plus interest on construction loans, typically qualify for capitalization under GAAP standards.<\/p>\n<p>Construction businesses don\u2019t usually have a choice about <a href=\"https:\/\/www.foundationsoft.com\/software\/job-costing\/\">paying costs<\/a>, but contractors may have the choice whether to treat them as an expense on their financials.<\/p>\n<p>According to <a href=\"https:\/\/www.mckinsey.com\/capabilities\/strategy-and-corporate-finance\/our-insights\/how-capital-expenditure-management-can-drive-performance\">McKinsey research<\/a>, cost and schedule overruns compared with <strong>original estimates frequently exceed 50% in construction projects<\/strong>, highlighting the critical importance of proper financial management.<\/p>\n<p>It\u2019s called <em>capitalization<\/em>, and it\u2019s not just for grammarians.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"What_Is_Expensing_in_Construction\"><\/span>What Is Expensing in Construction?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><b><strong class=\"PlaygroundEditorTheme__textBold\">Expensing<\/strong><\/b> <b><strong class=\"PlaygroundEditorTheme__textBold\">means recording construction costs<\/strong><\/b> <b><strong class=\"PlaygroundEditorTheme__textBold\">as immediate expenses on the P&amp;L statement<\/strong><\/b> rather than as assets. Let\u2019s look at an example under a traditional double-entry accounting system:<\/p>\n<a target=\"_blank\" href=\"\/construction-accounting-software-ebook\/\" class=\"blog-cta-image\"><img decoding=\"async\" src=\"\/wp-content\/uploads\/2024\/05\/2024-05-FSL-blog-post-ad-5-ways-ebook.png\" alt=\"eBook Download\" title=\"eBook Download\"><\/a>\n<p>Build-It Construction Co. is invoiced for a $500 equipment rental. They might record a $500 credit to increase their payables account, then a $500 debit to increase a general ledger account that&#8217;s dedicated to equipment expenses. As a result, their books balance, and their P&amp;L will show $500 less profit.<\/p>\n<table class=\"style-2\" style=\"height: 93px;\" width=\"300\">\n<tbody>\n<tr>\n<th>Account<\/th>\n<th>Debit<\/th>\n<th>Credit<\/th>\n<\/tr>\n<tr>\n<td>Equipment Expenses<\/td>\n<td>500<\/td>\n<td><\/td>\n<\/tr>\n<tr>\n<td>Accounts Payable<\/td>\n<td><\/td>\n<td>500<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<div class=\"clear\"><\/div>\n<div class=\"gdlr-space\" style=\"margin-top: 20px;\"><\/div>\n<h2><span class=\"ez-toc-section\" id=\"What_Is_Capitalization_in_Construction\"><\/span>What Is Capitalization in Construction?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><strong>Capitalization means recording construction purchases as balance sheet assets instead of immediate expenses<\/strong>. In construction accounting, to capitalize is to record a purchase <em>as an asset on the balance sheet<\/em> rather than as an expense on the income statement.<\/p>\n<p>The principle here is this: the value paid hasn\u2019t left the company, even if cash has gone out and even if they\u2019ve added debt. By categorizing the purchase as an <em>asset<\/em>, they\u2019re reporting the <em>value<\/em> it has for their business.<\/p>\n<p>Therefore, a sample capitalization entry will look different:<\/p>\n<table class=\"style-2\">\n<tbody>\n<tr>\n<th>Account<\/th>\n<th>Debit<\/th>\n<th>Credit<\/th>\n<\/tr>\n<tr>\n<td>Fixed Assets<\/td>\n<td>500<\/td>\n<td><\/td>\n<\/tr>\n<tr>\n<td>Accounts Payable<\/td>\n<td><\/td>\n<td>500<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<div class=\"clear\"><\/div>\n<div class=\"gdlr-space\" style=\"margin-top: 20px;\"><\/div>\n<p>Why capitalize? <strong>Capitalization allows contractors to recognize a large expense over time rather than as one big negative number on their P&amp;L.<\/strong><\/p>\n<p>The expense will still show up on financial statements \u2014 just gradually. The process of doing this is called <em>depreciation <\/em>for more concrete (\u201ctangible\u201d) assets or <em>amortization<\/em> for more abstract (\u201cintangible\u201d) assets.<\/p>\n<p>These methods systematically move a portion of its dollar value from assets to expenses over its expected useful, or, depreciable life.<\/p>\n<table class=\"style-2\">\n<tbody>\n<tr>\n<th>Account<\/th>\n<th>Debit<\/th>\n<th>Credit<\/th>\n<\/tr>\n<tr>\n<td>Depreciation Expense<\/td>\n<td>X,XXX<\/td>\n<td><\/td>\n<\/tr>\n<tr>\n<td>Accumulated Depreciation<\/td>\n<td><\/td>\n<td>X,XXX<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<div class=\"clear\"><\/div>\n<div class=\"gdlr-space\" style=\"margin-top: 20px;\"><\/div>\n<p>In short, <strong>capitalizing rather than expensing will show higher profits on the P&amp;L<\/strong> with higher taxes up front.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"What_Costs_are_Capitalized_During_Construction\"><\/span><strong>What Costs are Capitalized During Construction? <\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><strong>Capitalizable construction costs include direct materials, labor, equipment, permits and interest that create long-term asset value.<\/strong> To choose the right category, contractors must understand which costs count as assets versus expenses. Knowing the difference is crucial for recording and managing costs.<\/p>\n<p>Knowing the difference is crucial for properly recording and managing costs.<\/p>\n<p><strong>Asset: <\/strong><\/p>\n<ul>\n<li>Assets typically refer to the physical structures or improvements being constructed, such as buildings, infrastructure, machinery or equipment.<\/li>\n<li>Certain costs incurred that contribute to the creation or enhancement of these assets are capitalized, meaning they are added to the cost of the asset on the balance sheet rather than expensed immediately.<\/li>\n<\/ul>\n<p><strong>Expense: <\/strong><\/p>\n<ul>\n<li>Expense costs in construction are expensed immediately on the income statement during the period they are incurred.<\/li>\n<li>An expense is a cost incurred while generating revenue for a business. These typically refer to costs immediately recognized on the income statement during the period they are incurred.<\/li>\n<li>Construction expenses can include general administrative expenses, advertising costs and certain overhead costs that are not directly attributed to the project. Any costs incurred for repairs, maintenance or improvements are often expensed rather than capitalized.<\/li>\n<\/ul>\n<p>Essentially, assets <em>are not capitalized<\/em>. Costs associated with the construction process, aka expenses, <em>are capitalized costs<\/em>. For most construction projects, specific expenses that are capitalized include:<\/p>\n<ol>\n<li><strong>Direct Costs:<\/strong> These are directly attributed to the construction process. There are material direct costs which consist of the building materials specifically used in the construction process, direct labor costs which refer to the wages and benefits paid to workers and equipment direct costs which refer to asset rentals.<\/li>\n<li><strong>Indirect Costs:<\/strong> Also referred to as overhead costs, these are expenses that are not directly attributable to the construction process but are necessary for it to occur. This can include costs such as supervision, permits, utilities and insurance.<\/li>\n<li><strong>Interest Costs:<\/strong> Also known as capitalized interest, these costs refer to the interest incurred on loans used to finance the construction and may be capitalized under certain conditions, however, it is typically only applicable to self-constructed assets.<\/li>\n<li><strong>Permit Fees, Professional Fees and Regulatory Costs: All<\/strong> costs associated with obtaining necessary permits, professionals involved in the design or planning process and complying with regulatory requirements.<\/li>\n<li><strong>Land Preparation Costs:<\/strong> These costs typically refer to any expenses incurred in the preparation of the jobsite, such as excavation, grading and land clearing.<\/li>\n<\/ol>\n<p>In the construction industry, every project varies, so determining which costs should be capitalized for your specific job beforehand can help create a smoother process.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"When_to_Capitalize_Costs_During_Construction\"><\/span>When to Capitalize Costs During Construction<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Construction costs should be capitalized when they generate future revenue and provide benefits beyond one fiscal period. Generally, companies capitalize when they expect to use the value of a purchase over a long period of time.<\/p>\n<p>In other words, they decide that it\u2019s a long-term investment called a <strong>capital expenditure<\/strong>. It\u2019ll follow two rules:<\/p>\n<ol>\n<li>They\u2019ll use the purchase for generating revenue.<\/li>\n<li>They expect to use it for more than one fiscal period.<\/li>\n<\/ol>\n<p>Otherwise, a contractor will expense.<\/p>\n<p>For example, Build-It Construction Co.\u2019s equipment rental doesn\u2019t fit those two criteria above. Depending on how they\u2019re <a href=\"\/learn\/contractors-new-revenue-recognition\/\">recognizing job revenue<\/a>, lumber or paint used on a regularly invoiced project wouldn&#8217;t fit the bill either.<\/p>\n<p>All of these are \u201cconsumed\u201d during the cost\u2019s reporting period, meaning no value is left over for the company to report.<\/p>\n<p>This follows the \u201cmatching principle&#8221; of accounting, which keeps expenses reported in the same period as the revenues they generate.<\/p>\n<p>If the company buys the equipment outright or even leases it, that\u2019s a different story. It would also be different if they were purchasing or building property for their own business use, such as a warehouse \u2014 or even technology like tablets and software. In this case, they might also capitalize related costs, including interest on financing.<\/p>\n<div class=\"clear\"><\/div>\n<div class=\"gdlr-space\" style=\"margin-top: 20px;\"><\/div>\n<h2><span class=\"ez-toc-section\" id=\"Creating_a_Capitalization_Policy\"><\/span>Creating a Capitalization Policy<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Effective capitalization policies establish clear dollar thresholds and criteria for consistent expense versus asset classification. There exists a wealth of fine-grain guidance for contractors to be aware of when creating or applying a capitalization policy.<\/p>\n<p>These include FASB standards on when to capitalize, plus GAAP and IRS requirements for the amounts they can expense. There are also safe harbor elections and considerations for whether companies produce audited financial statements.<\/p>\n<a target=\"_blank\" href=\"\/learn\/#schedule-a-live-demo\" class=\"blog-cta-image\"><img decoding=\"async\" src=\"\/wp-content\/uploads\/2024\/03\/FSL-blog-post-ad-see-how.png\" alt=\"Get a Demo\" title=\"Get a Demo\"><\/a>\n<p>&nbsp;<\/p>\n<p>Construction companies need to have a consistent policy they use to determine when to capitalize during a project. Just as an example, you might require expensing all purchased items below $500.<\/p>\n<p>A policy should be the same for both internal bookkeeping and tax reporting purposes. However, contractors may be able to change their policy from one year to the next.<\/p>\n<p>To <strong>take advantage of capitalization<\/strong>, the most important thing you can do is <strong>talk with your construction CPA<\/strong> about what would make sense for your situation.<\/p>\n<p>Lean on their expertise, and make sure you&#8217;re doing what makes sense for your business.<\/p>\n<div id=\"for-more-box\"><a class=\"gdlr-button medium\" href=\"\/learn\/what-is-a-construction-cpa\/\" target=\"_self\"  style=\"color:#ffffff; background-color:#000000; border-color:#999999; \"  >Up Next: How to Find a Construction CPA \u00bb<\/a><\/div>\n","protected":false},"excerpt":{"rendered":"<p>Construction businesses don\u2019t usually have a choice about paying costs, but contractors may have the choice whether to treat them as an expense on their financials. It\u2019s called capitalization, and it\u2019s not just for grammarians.<\/p>\n","protected":false},"author":17,"featured_media":1495,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_searchwp_excluded":"","inline_featured_image":false,"footnotes":""},"categories":[9,16],"tags":[11,20],"class_list":["post-12199","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-articles","category-reporting-bookkeeping","tag-construction-reporting","tag-video"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.0 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Capitalize vs. Expense: Tax Strategies for Contractors<\/title>\n<meta name=\"description\" content=\"Learn when construction costs should be capitalized vs. expensed. Expert guidance on materials, labor, permits, and GAAP compliance. Get clarity today.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.foundationsoft.com\/learn\/capitalize-vs-expense\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"When to Capitalize vs. Expense Costs on a Construction Project\" \/>\n<meta property=\"og:description\" content=\"Construction businesses don\u2019t usually have a choice about paying costs, but contractors may have the choice whether to treat them as an expense on their financials. 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