Construction in progress accounting is the process of collecting every capitalizable cost of building a long-term asset in a temporary balance sheet account, then transferring the total to a permanent fixed asset account once the asset is ready for use. The CIP account sits inside property, plant, and equipment as a non-current asset, but nothing in it depreciates. Depreciation only starts after the transfer. Getting the account right determines your depreciable basis, the timing of your tax deductions, and whether your financial statements track what you actually built.
What Belongs in the CIP Account
Any cost necessary to bring the asset to its intended use and location is a candidate for capitalization. In practice the costs fall into three groups: direct costs, indirect costs, and interest.
Direct Costs
Direct costs are the ones you can point at. Materials like steel, concrete, lumber, and permanently installed equipment. Labor, including wages, payroll taxes, and benefits for workers whose time is on the project. Track labor through time sheets or 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-related legal costs, and site preparation qualify. General overhead like site utilities or temporary security must be allocated to the project using a consistent method, typically based on direct labor hours or material costs. Pick an allocation method early and hold to it for the life of the project.
Capitalized Interest
Borrowing costs incurred during construction are capitalized rather than expensed when the asset qualifies. For tax purposes, 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), a production period exceeding two years, or a production period over 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 uses the “avoided cost method,” which asks how much interest you theoretically could have avoided if you had used the construction spending to pay down debt.2eCFR. 26 CFR 1.263A-9 – The Avoided Cost Method Under GAAP, the capitalized amount is capped at the actual interest incurred for the period, and the amount is determined by applying a capitalization rate to the weighted-average accumulated expenditures on the asset.
The capitalization period starts once you’ve begun spending and construction activities are underway. It ends when the asset is substantially complete and ready for its intended use. One important carve-out: small businesses meeting the Section 448(c) gross receipts test, generally those averaging $31 million or less in annual gross receipts (adjusted for inflation), are exempt from Section 263A entirely, including its interest rules.3eCFR. 26 CFR 1.263A-8 – Requirement to Capitalize Interest
Repair or Improvement: The Line That Decides Capitalization
The most common CIP mistake is capitalizing a cost that should have been expensed, or expensing one that should have been capitalized. The IRS tangible property regulations set the line with three tests. An expenditure 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 (an expansion, extension, or major component), or materially increases the property’s productivity, efficiency, or output.
- Restoration: the work replaces a major component or a substantial structural part, returns non-functional property to working condition, or rebuilds the property 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. Scope and effect decide the classification, not the dollar amount alone.
The de minimis safe harbor gives you a workable bright line for smaller items. If you have an applicable financial statement, you can expense amounts up to $5,000 per invoice or item. Without one, the threshold is $2,500.5Internal Revenue Service. Tangible Property Regulations – Frequently Asked Questions You elect it annually by attaching a statement to your return, and you need a written accounting policy in place at the start of the year. A separate 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. Those never belong in CIP.
Managing the CIP Ledger During Construction
An unmanaged CIP account becomes a dumping ground. Costs get miscoded, audit trails go cold, and the eventual transfer to fixed assets turns into an archaeological dig. A few controls save enormous pain later.
Every capital project needs its own project code. Every purchase order, invoice, and labor entry must reference the correct one. This is how construction spending stays separated from ordinary operating expenses, and how simultaneous projects avoid cross-contamination with each other.
Every cost in the account needs a paper trail: vendor invoices, executed contracts, time sheets, allocation memos. For capitalized interest, keep the loan agreements, payment schedules, and worksheets showing weighted-average accumulated expenditures. Auditors want to see the invoices, the approval chain, and the logic connecting each cost to the asset, not just a summary total.
Run periodic reviews of everything sitting in CIP. Apply the betterment, restoration, and adaptation tests to confirm each expenditure genuinely qualifies as a capital cost.4eCFR. 26 CFR 1.263(a)-3 – Amounts Paid to Improve Tangible Property Reclassify anything routine before the account closes. Catching errors during construction is far easier than unwinding them after the asset is in service.
Transferring CIP to a Fixed Asset
CIP is a temporary account. Once construction is done, the balance moves to a permanent fixed asset account, and that transfer sets the depreciable basis. The mechanics are simple. The timing decision is not.
The In-Service Date
The in-service date is the most consequential judgment call in the whole process. For IRS purposes, property is “placed in service” when it is ready and available for a specific use, whether or not you have 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 can store inventory.
That date triggers two things at once: interest capitalization stops, and depreciation starts. Set the date too early and you lose legitimate capitalizable costs. Set it too late and you delay depreciation deductions you’re entitled to while overcapitalizing interest. Support your date with objective evidence: a certificate of occupancy, a final inspection sign-off, a documented operational readiness assessment.
The Journal Entry
The entry is clean. Debit the permanent fixed asset account (Buildings, or Machinery and Equipment) for the accumulated total, and credit CIP for the same amount. Accumulate $5,000,000 in CIP for a new manufacturing facility and the entry debits Buildings for $5,000,000 and credits Construction in Progress for $5,000,000. The CIP balance goes to zero. The building lives in the fixed asset register at its full historical cost.
Depreciation After the Transfer
Once the balance moves, depreciation begins. Most business property is depreciated for tax purposes under the Modified Accelerated Cost Recovery System. MACRS treats salvage value as zero, so you depreciate the full cost basis.7Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System The recovery period depends 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. But 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 applies instead, which can meaningfully reduce your 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 makes the in-service date for large equipment projects a front-line planning decision.
Section 179 offers 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 interior improvements to nonresidential buildings. The two provisions can interact, so map out which assets use which deduction.
Energy Efficiency Deduction
If the project involves a commercial building designed for energy efficiency, the Section 179D deduction may apply. For 2025, the deduction ranged from $0.58 to $5.81 per square foot depending on the level of energy savings achieved and whether prevailing wage and apprenticeship requirements were met.9Department of Energy. 179D Energy Efficient Commercial Buildings Tax Deduction Under current law, Section 179D does not apply to property where construction begins after June 30, 2026, so the window is closing. Factor the energy modeling requirements into design early enough to qualify.
Book Depreciation Diverges
Financial reporting under GAAP uses estimated useful lives and salvage values rather than the MACRS recovery periods, so the depreciable basis on your books and the depreciable basis on your return usually differ from the start. Straight-line spreads an equal charge across every period of the estimated useful life and is the most common choice for buildings. For complex assets like commercial buildings, component depreciation splits the total cost into major pieces (structural shell, roof, HVAC, elevators, electrical) and gives each component its own useful life. That approach also matters on the tax side, where a cost segregation study can reclassify building components into shorter MACRS periods and pull deductions forward.
When a Project Is Abandoned or Impaired
Not every project reaches the finish line. When it doesn’t, the accumulated costs in CIP need proper treatment for both book and tax purposes.
If you permanently abandon a construction project, the accumulated costs in CIP become deductible as an ordinary loss under Section 165.10Office of the Law Revision Counsel. 26 USC 165 – Losses The key word is “permanently.” The IRS wants clear evidence that you have discarded the project with no intention of recovering the costs: a board resolution, a formal written decision to halt, documented changes in strategy. If the abandonment is ambiguous or could be characterized as a sale or exchange, the loss may be reclassified as a capital loss, which is far less useful since capital losses can only offset capital gains. The scope of the deductible loss includes everything accumulated in CIP up to the point of abandonment: land preparation, design fees, engineering work, materials, labor. The journal entry reverses the CIP balance into a loss account on the income statement.
Even without abandonment, GAAP requires an impairment test 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 alone requires 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 the carrying amount exceeds those cash flows, write the asset down to fair value and recognize the difference as a loss.