Filing of Form 3115 may be necessary by June 19, 1995 to obtain automatic approval (including audit relief) for changes to comply with final interest capitalization regulations.

• Author: Conjura, Carol

Final regulations addressing the requirement to capitalize interest expense under Sec. 263A(f) with respect to the production of property were issued in December 1994, effective for tax years beginning after Dec. 31, 1994. By law, the interest capitalization rules affect a narrower group of activities than the general uniform capitalization rules, applying primarily to real estate development for self-use or sale, the production of long-lived property used in a trade or business, and the production of significant tangible personal property produced for self-use or sale. To implement the transition, the IRS issued Rev. Proc. 95-19 to provide automatic consent for taxpayers to change their method of capitalizing interest to a method in conformity with the final regulations.

Taxpayers eligible for Rev. Proc. 95-19 must follow the procedures and make the change for their first tax year beginning in 1995, but are given the option to make the change one year earlier and coordinate this change with their change to the final regulations for noninterest costs. If a taxpayer is eligible to make the change, Rev. Proc. 95-19 is also the exclusive available procedure for either of these years.

The scope of the automatic procedure includes changes from methods of capitalizing interest that are both proper and improper methods under the preexisting guidance, which generally included the statute, legislative history and IRS Notice 88-99. For example, a taxpayer may make the automatic change in method of accounting under Rev. Proc. 95-19 if it erroneously capitalized no interest; capitalized interest, but erroneously computed the amount of interest required to be capitalized; or capitalized the correct amount of interest, but now wants to take advantage of a more favorable option in the final regulations, such as using an annual computation period that minimizes the compounding of capitalized interest or using the more liberal rule for expensing interest incurred during production suspension periods adopted in the final regulations.

Prior to the issuance of the final regulations, many issues on interest capitalization were open to interpretation, and taxpayers had a significant amount of flexibility to apply these rules in a reasonable manner. However, many positions adopted by taxpayers for prior years, even though reasonable and not subject to penalties if necessary disclosures were made, may differ from the position asserted by the Service on...