On October 2nd, the IRS finalized regulations under TD 10034 that remove the associated-property rule from interest capitalization for improvements to designated property, a change that will apply to Philadelphia rental portfolios beginning with 2026 calendar-year returns.
IRS Final Rule Removes Associated-Property Rule
The rule eliminates interest capitalization tied to the adjusted basis of property temporarily withdrawn from service to complete an improvement and aligns with the Federal Circuit’s Dominion Resources decision.
For background on how the agency removes the associated-property rule from interest capitalization regulations, see the linked coverage.
The final rule applies to tax years beginning after October 2nd, 2025.
Key Changes to APEs and the Definition of Improvement
Under the final regulations, accumulated production expenditures now include only the direct and indirect costs of the improvement itself.
The rules remove an allocable portion of land cost and the adjusted basis of associated property from APEs.
The regulations clarify that improvements are defined under Reg. 1.263(a)-3 while repairs under Reg. 1.162-4(a) are excluded.
Prior coverage of the final rules adopt cutback in interest capitalization requirements for property improvements details these definitional updates.
Philadelphia Project Scenarios Affected by the Rule Change
Removing associated property from APEs directly affects projects that idle units or buildings during construction, such as elevator overhauls in Center City towers, HVAC replacements in University City mid-rises, or gut rehabs of rowhouses in Brewerytown.
With only improvement costs counted, operators should expect less interest capitalized during shutdown periods, which changes how carrying costs are reflected while units are off market.
This can influence turnover scheduling and leasing velocity when bringing renovated inventory online in tight submarkets.
Effective Dates and Coordination With Interest Limitation Rules
Taxpayers could apply proposed rules for tax years beginning after May 15th, 2024.
The final regulations apply for tax years beginning after October 2nd, 2025.
The One Big Beautiful Bill Act adjusts Section 163(j) for tax years beginning after December 31st, 2025, and the change generally aligns timing with the new rule set.
Interest required to be capitalized under Section 263A(f) remains outside that adjustment.
Additional context is available where IRS issues final interest capitalization regulations.
Accounting Method Mechanics for Ongoing Capital Work
Implementing the final regulations is a change in method of accounting subject to Sections 446 and 481, which puts more weight on accurate project-level cost capture across Philadelphia portfolios.
Because improvements fall under Reg. 1.263(a)-3 and repairs do not, classification choices will determine whether interest must be capitalized during production periods.
For owners and managers coordinating multi-phase rehabs, this shifts documentation and project tracking requirements across active construction calendars in 2026.