Carrying charges are the recurring costs of holding an asset over time — property taxes, interest on debt used to buy it, insurance, storage, and similar expenses that accrue whether or not the asset produces income. Some of these charges are deductible in the year you pay them, some must be added to the asset’s cost basis, and for certain kinds of property you get to choose. The right classification changes when you get the tax benefit and, in some cases, whether you get one at all.
What Counts as a Carrying Charge
A carrying charge is any expense you incur simply because you still own the asset. Common examples: property taxes on land, mortgage interest on an acquisition loan, insurance premiums, warehouse rent for inventory, vault fees for physical gold, and margin interest on borrowed funds used to buy securities. These costs accumulate on their own schedule, independent of whether the asset is generating revenue.
Because carrying charges eat directly into your net return, their tax treatment matters. If a parcel of land appreciates by $20,000 over five years but you spent $25,000 on taxes, interest, and insurance during that period, you have a net economic loss regardless of the sale price. Whether those five years of charges reduced your income tax along the way, or instead built up your basis to shrink the eventual gain, is what the rules below decide.
Real Estate: Deduct Now or Add to Basis
Undeveloped or non-income-producing real estate is where the deduct-versus-capitalize question comes up most often. You pay annual property taxes, mortgage interest on any acquisition debt, and liability insurance for as long as you own the parcel. None of that goes away while the land sits idle.
Treatment depends on whether the property produces income. On an actively rented property, operating costs like insurance and repairs are ordinary deductions against rental income. On land or a building that produces no income, you face a real choice each year: deduct the carrying charges against your other income now, or capitalize them into the property’s cost basis for a benefit later. That choice runs through Section 266 of the Internal Revenue Code.
The Section 266 Election
Section 266 lets you elect to capitalize carrying charges that would otherwise be deductible, adding them to the property’s basis instead of claiming a current-year deduction.1eCFR. 26 CFR 1.266-1 – Taxes and Carrying Charges Chargeable to Capital Account and Treated as Capital Items For unimproved and unproductive real property, eligible charges include annual property taxes, mortgage interest, and other holding costs.
Why voluntarily give up a current deduction? Usually because it isn’t worth much right now. If you’re in a low-income year, already showing a loss, or expect to be in a much higher bracket when you sell, a deduction today saves less tax than a larger basis will save later. Capitalizing shifts the benefit to the sale, where it shrinks your capital gain.
How to Make the Election
There is no dedicated IRS form. You attach a statement to your original return for the year, filed by the due date including extensions, identifying the property, describing each charge you’re capitalizing, and listing the dollar amounts. Then you simply don’t claim those charges as deductions on that return.1eCFR. 26 CFR 1.266-1 – Taxes and Carrying Charges Chargeable to Capital Account and Treated as Capital Items
The election works differently by property type. For unimproved and unproductive real property, it’s a year-by-year decision that does not carry forward. For property under development or construction, the election locks in until the project is completed. For personal property, it holds until the property is installed or first put to use, whichever is later. You can’t switch course midway through a construction project and start deducting charges you previously elected to capitalize.1eCFR. 26 CFR 1.266-1 – Taxes and Carrying Charges Chargeable to Capital Account and Treated as Capital Items
Investment Carrying Charges
Charges tied to holding financial assets follow their own rules, and each category is treated differently.
Margin Interest
Interest paid to a broker on borrowed funds used to buy securities is “investment interest expense” under Section 163(d). It’s deductible, but only up to your net investment income for the year — generally interest, ordinary dividends, and certain other investment income, reduced by investment expenses.2Office of the Law Revision Counsel. 26 U.S. Code 163 – Interest You calculate the deduction on Form 4952. Any excess over your net investment income carries forward to the next year and is treated as investment interest paid in that year, with no expiration.3Internal Revenue Service. About Form 4952, Investment Interest Expense Deduction
Custodial and Advisory Fees
Fees paid to brokerage firms, trust companies, or investment advisors to manage and safeguard your assets are carrying charges, but they produce no current tax benefit for most individual investors. They used to qualify as miscellaneous itemized deductions subject to the 2% floor. The Tax Cuts and Jobs Act suspended that deduction starting in 2018, and the One Big Beautiful Bill Act of 2025 made the elimination permanent. Absent future legislation, these fees stay nondeductible.
Brokerage Commissions
Commissions aren’t recurring holding costs at all. A purchase commission gets added to your cost basis in the security, and a selling commission reduces the amount realized on sale.4Internal Revenue Service. Topic No. 703, Basis of Assets
Physical Commodities
Storage and insurance for gold, silver, and other physical commodities are real carrying charges that paper investments avoid. They’re not deductible for an individual investor holding the metal as an investment. They do erode your return dollar for dollar, since the commodity itself produces no income.
Inventory: UNICAP Rules
Businesses that hold physical goods for resale, or that produce property, generally can’t just deduct inventory-related carrying charges as current operating expenses. Under the Uniform Capitalization rules in Section 263A, both direct costs and a share of indirect costs — including taxes — must be capitalized into the cost of inventory. The tax benefit is deferred until the inventory sells and the cost flows out through cost of goods sold.5Office of the Law Revision Counsel. 26 U.S. Code 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses The IRS treats UNICAP as a timing rule rather than a disallowance rule; the deduction isn’t lost, just delayed.6Internal Revenue Service. Section 263A Costs for Self-Constructed Assets
Small Business Exemption
Not every business gets pulled into UNICAP. Small business taxpayers — businesses other than tax shelters whose average annual gross receipts for the three prior tax years don’t exceed an inflation-indexed threshold — are exempt. For taxable years beginning in 2025, that threshold is $31 million.7Internal Revenue Service. Rev. Proc. 2024-40 Businesses below the line can deduct inventory-related carrying charges in the year incurred rather than capitalizing them.
Construction Period Interest Is Mandatory
When you’re building or producing real property, capitalization stops being optional. Section 263A(f) requires interest incurred during the production period to be capitalized when the property has a long useful life, when the estimated production period exceeds two years, or when the production period exceeds one year and the project costs more than $1 million.5Office of the Law Revision Counsel. 26 U.S. Code 263A – Capitalization and Inclusion in Inventory Costs of Certain Expenses
The production period begins with the first physical activity on the project, such as clearing land, demolition, or breaking ground on infrastructure. From that point until completion, interest on debt allocable to the project must be folded into the property’s basis. The IRS requires the “avoided cost method” to compute the capitalized amount. The small business gross receipts exemption applies here too, so qualifying taxpayers below the threshold aren’t subject to these mandatory rules.
What Capitalized Charges Do When You Sell
Every charge you capitalize increases your cost basis. When you sell, your taxable gain is the sale price minus your adjusted basis, so a higher basis produces a smaller gain and a smaller tax bill. That’s the payoff for skipping the deduction along the way.
Sales of capital assets are reported on Form 8949, listing proceeds, adjusted basis (including capitalized carrying charges), and the resulting gain or loss. Totals flow to Schedule D of Form 1040.8Internal Revenue Service. About Form 8949, Sales and Other Dispositions of Capital Assets Keep thorough records of every capitalized charge — the year, the amount, and the election statement you filed. If the IRS questions your basis and you can’t document it, you can lose the adjustment and pay tax on a larger gain than you actually realized.
Fixing a Past Misclassification
If you’ve been deducting carrying charges that should have been capitalized, or capitalizing charges that were eligible for immediate deduction, this generally isn’t an amended-return fix. A change in how you classify carrying charges is a change in accounting method, which requires filing Form 3115 and calculating a Section 481(a) adjustment for the cumulative difference.9Internal Revenue Service. About Form 3115, Application for Change in Accounting Method The mechanics are involved enough that professional help on the filing usually pays for itself, since errors in the adjustment can invite additional scrutiny.