Rev. Rul. 2008-18: Capitalizing Creative Project Costs
Explore the tax principles that define costs for creative works as a capital investment rather than an immediate business expense for the producer.
When a person or a business creates a valuable asset, an accounting question arises regarding the treatment of costs from the creation process. For tangible assets like buildings, the costs become part of the asset’s value. The financial treatment is less obvious for intangible assets, such as a novel’s manuscript or a film’s master recording, which involve many expenditures before the final product exists.
The core issue is whether to deduct costs as immediate business expenses or to capitalize them. Capitalizing means bundling these costs into the value of the creative work itself, to be recovered over time as the asset generates income. This choice directly impacts the calculation of taxable income for creators and production companies.
Understanding the Uniform Capitalization Rules
The framework for these questions is found within the Uniform Capitalization (UNICAP) rules, detailed in Section 263A of the Internal Revenue Code. These rules mandate that for certain types of property, the costs associated with its creation cannot be immediately deducted and must be capitalized. To “capitalize” a cost means to add it to the basis of the asset. The basis is the investment in the property for tax purposes, and this value is used to calculate depreciation or the gain or loss upon the asset’s sale.
The UNICAP rules apply to taxpayers who produce property, a term that includes constructing, developing, or improving property. The rules require capitalizing both direct costs and a share of indirect costs that are allocable to the produced property. For example, the direct costs of furniture are the wood and screws. Indirect costs support the production process but are not part of the final product, such as rent for the workshop or electricity for tools. A portion of these indirect costs must be allocated to the furniture’s capitalized cost.
Applying UNICAP to Creative Works
The Self-Employed Author
A self-employed author writing a non-fiction book incurs numerous expenses directly related to the project. These include payments for research assistance, purchasing reference materials, and travel expenses for interviews. The author also has costs for office supplies like paper and ink used in printing drafts.
The tax code provides an exception for many self-employed creators. Freelance writers, photographers, and artists can deduct their “qualified creative expenses” in the year they are incurred, rather than capitalizing them. This exception does not extend to expenses for producing motion pictures, sound recordings, or video tapes.
The Film Production Corporation
A corporation producing motion pictures begins by acquiring a screenplay. From there, the corporation incurs costs including salaries for actors, directors, and cinematographers. It also spends on set construction, location fees, and the creation of special effects. Administrative staff are paid to manage the logistics of the entire production. These costs, from the initial script acquisition to the final edit, are all part of producing the finished film.
The Music Production Corporation
A corporation that produces musical compositions employs a team of songwriters and composers to create new songs. The costs include the salaries paid to the creative staff and the provision of studio space and recording equipment. The corporation might also incur expenses for collaborating with outside artists or securing rights to sample other musical works. These costs are a component of producing a final master recording.
The General Rule and Its Application
The Uniform Capitalization rules require that the costs incurred by a producer to create property be capitalized. For a film producer or music production company, the completed motion picture or master recording are tangible properties they have produced. Therefore, the direct and allocable indirect costs associated with their creation must be capitalized. These costs become part of the value of the creative asset they helped produce.
The regulations provide for several simplified methods to account for the complexity of tracking and allocating every indirect cost. For producers of creative property, the “simplified production method” is a permissible option for capitalizing these costs. This method avoids a detailed allocation of indirect costs between production activities and overall business operations by using a formula to determine the amount that must be capitalized.
Under the simplified production method, a producer calculates an “absorption ratio.” This ratio is derived by dividing the total additional UNICAP costs (indirect costs that need to be capitalized) by the total direct costs.
This ratio is then multiplied by the direct costs associated with the property that is still on hand at the end of the year. The result is the amount of indirect costs that must be capitalized to that property, providing a practical way to comply with the UNICAP rules.