The State statutes and the tax-exempt bond rules generally provide that borrowed money can only be used to pay “capital costs” of a project. But what is a “capital cost,” or a “capital expenditure,” exactly? Let’s split the question into a few sections.
For new construction or the acquisition of new property or equipment
Any cost you need to pay to fully put the property in service and use it for the intended purpose will be a capital cost. That will include both hard costs (such as buying land or paying a contractor) and soft costs (design and permitting fees).
Interest payments attributable to time prior to the placed-in-service date (and for some limited time thereafter) are capital costs, but on-going interest payments are not capital costs. Costs can be “capital costs” even if they take the form of payment, for in-house services – we wrote a blog post about that.
Costs to improve or restore existing property
Note that the term “improve” is used in the tax rules as the opposite of “maintain,” and we’ll discuss that difference below.
These would all be capital expenditures:
- If you are fixing a problem that arose during construction
- If you are fixing something that arises from a casualty loss
- If you are adapting an asset to another use – such as converting a school to an office building
- If you are adding on to an existing building
- If you are replacing a component that’s come to the end of its useful life – like a brand-new roof
“Improvement” or “maintenance”
You might wonder, doesn’t all the money I spend on my existing building somehow “improve” it, at least a little it? This is where the IRS makes a distinction and asks whether an expenditure expands or increases operational quality or condition (a capital “improvement”), or merely preserves that quality or condition (non-capital “maintenance”). Even then, there’s nuance.
Generally replacing carpet, painting, or patching a roof that still has some years left would all fall into the maintenance category. If you’re replacing carpet and re-painting to fix flood damage, that will be a capital improvement. If you replace windows with new energy efficient models, that probably increases operational quality. If you replace windows with the same old model, probably not.
We should also point out that whatever the State statutes or tax law might allow as a use of financing proceeds for capital costs, the LGC staff will have its own concerns. For example, the LGC staff does not like the idea of using financing proceeds to pay for in-house costs, and also frowns upon capitalizing interest for general fund projects. Those limitations are not in the statutes, and there’s room for discussion if financing those costs is important to you for a particular project.
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The rules around “capital costs” can be complicated and confusing, and in a blog post we try to hit the highlights and try to be not overly technical. We’d love to talk to you directly if you have a particular question about this topic.
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