Capitalization, Impairment and Foresight for Real Estate Development Projects

Real estate development is not for the faint of heart. It’s a high-stakes, capital-intensive endeavor where financial missteps can derail even the most promising projects. From the moment a parcel of land is identified to the day tenants move in, or units are sold, developers must navigate a labyrinth of accounting rules that govern how to track, capitalize and report costs. These decisions affect more than compliance — they shape investor confidence, tax outcomes and long-term financial flexibility.

Below we explore the accounting that underpins real estate development, focusing on three critical pillars: capitalization of costs, interest capitalization and impairment testing. We also examine broader considerations, such as revenue recognition, project segmentation and disclosure strategies that elevate financial reporting from a compliance exercise to a strategic asset.

What to Know Before Acquiring a Development Property

When pursuing a new project, developers should capitalize any preacquisition costs — if in fact those costs would be capitalized during the project. Preacquisition costs are defined as expenses related to a property incurred specifically for and prior to obtaining the property.

Common examples include:

• Payments to secure an option on the land,
• Zoning and city approval fees,
• Environmental or feasibility studies,
• Legal services and finder’s fees,
• Appraisals, and
• Project planning expenses.

However, if the project does not move forward, the developer may expense, instead of capitalize, these preacquisition costs.

In addition, if the developer has any internal costs related to preacquisition activities — such as an internal acquisition department where employees search for and manage acquisitions of real estate — these costs will fall under Accounting Standards Codification (ASC) 970-340-25-6. Capitalize these costs when they:

• Are directly attributable to the property being acquired,
• Relate to a property designated as nonoperating at the acquisition date, and
• Are incurred after the acquisition of that specific property is considered probable.

For example, under accounting principles generally accepted in the United States of America (GAAP), if a developer is planning to build an apartment building on a specific piece of land and the acquisition of that land is considered probable, the developer would capitalize any internal costs directly associated with acquiring the land.

Read “Step-by-Step Guide to Recording Your Real Estate Purchase: From Closing to the General Ledger” for comprehensive guidance on recording a purchase of an acquired asset.

What to Know After the Property is Acquired

First, it’s important to determine which development costs are capitalized and which are expensed. Under GAAP, particularly ASC 970 (Real Estate — General) and ASC 360 (Property, Plant and Equipment), developers are permitted to capitalize costs directly attributable to the acquisition, development and construction of a real estate project. These include:

• Land acquisition costs: Purchase price, legal fees, demolition costs (discussed below) and due diligence
• Construction and labor: Materials, general and subcontractor payments, and site preparation
• Professional services: Architects, engineers, legal counsel and consultants
• Permitting and entitlement: Zoning applications, environmental studies and municipal fees
• Taxes and insurance: Property taxes and builder’s risk insurance during development should be accounted for in a manner similar to interest costs, since the period of capitalization is the same
• Interest costs: Capitalized under ASC 835

These costs must be incurred during the development period and cease to be capitalized once the asset is “substantially complete” and ready for its intended use — whether for lease, sale or occupancy.

During development, there are a few other items to address separately, if they come up:

• Demolition Costs: When a property is acquired with an existing building intended for demolition, demolition costs may be capitalized as part of the acquisition if planned at purchase and carried out within a reasonable period (or delayed due to factors beyond the entity’s control, such as tenant lease expirations or permitting). If the property is acquired with the intent to demolish and rebuild, both the purchase price and demolition costs are allocated to land.
• Incidental Operations: Net revenues from incidental operations that exceed related costs are recorded as a reduction of capitalized project costs, as they help offset development expenses. When costs exceed revenues, the excess is expensed as incurred, since such activities do not reduce the cost of preparing the property for its intended use. For example, if land is temporarily used as a parking lot while awaiting construction permits, any net revenues above costs reduce the overall development costs of the project.

What Must Be Expensed?

Not all costs qualify for capitalization, including the following:

• General and administrative overhead covers the costs of running a developer’s company that are not tied to a specific development project, such as executive management, office operations, administrative staff, IT systems, insurance and professional services.
• Marketing and selling expenses extend far beyond advertising and brokerage fees. They encompass market research, branding, promotional events, digital infrastructure like CRM systems and virtual tours, as well as customer experience investments such as model units and post-sale support.
• Idle equipment or labor downtime.
• Feasibility studies that do not lead to acquisition.

The distinction between costs that can be capitalized or expensed is not just academic — it has real implications for earnings volatility, tax liabilities and investor perception. We’ve seen many examples where the developer capitalizes all costs associated with a new development project, and then later finds out a large portion of those costs should be expensed. This can result in restatements, audit findings or even regulatory scrutiny.

Interest Capitalization: Timing, Technique and Traps

Interest capitalization is one of the most nuanced, and frequently misunderstood, areas in real estate accounting. Interest costs, that theoretically could have been avoided if expenditures for qualifying assets had not been made, should be capitalized. ASC 835-20, allows developers to capitalize interest costs incurred during the construction of qualifying assets, such as the following:

• Internal-use assets: Assets constructed or produced for the entity’s own use, including those built by third parties with deposits or progress payments.
• Sale or lease assets: Discrete projects intended for sale or lease, such as real estate developments that qualify under ASC 970.
• Equity-method investments: Investments in an investee engaged in activities to begin principal operations, where funds are used to acquire qualifying assets. For capitalization, the qualifying asset is the investor’s overall investment, not the investee’s individual projects.

When Does Interest Capitalization Begin?

Three conditions must be met to initiate the capitalization window:

1. Expenditures for the asset are being incurred.
2. Activities necessary to prepare the asset for use are in progress.
3. Interest cost is being incurred.

The capitalization window remains open until the asset is substantially complete or until development has been suspended for a significant duration. Temporary interruptions — such as those caused by adverse weather, labor strikes or delays inherent to the acquisition process — do not require a developer to halt interest capitalization.

How Is Interest Capitalization Calculated?

Capitalized interest is calculated using the weighted average accumulated expenditures for the project during the period, multiplied by the applicable interest rate. If the project has specific financing, that rate is used. Otherwise, a weighted average rate of other borrowings applies.

Example:

• Accumulated expenditures: $10 million
• Interest rate: 6%
• Capitalized interest: $600,000

Common Pitfalls

• Capitalizing interest after project completion
• Failing to suspend capitalization during delays
• Using the wrong interest rate, such as corporate debt instead of project-specific financing

These errors can distort project economics and mislead stakeholders about the true cost of development.

Impairment Testing: Navigating the Downside

Real estate development is inherently risky. Projects can stall, markets can shift and assumptions can unravel. When the carrying amount of a project exceeds its recoverable value, impairment testing under ASC 360 becomes mandatory.

When to Test for Impairment

Impairment testing is triggered by events or changes in circumstances that suggest the asset may not be recoverable. These include:

• Significant decline in market value is often the most obvious trigger, suggesting the asset’s carrying amount may exceed its fair value.
• Change in use of the development project, such as shifting from residential to commercial or reducing planned capacity, can signal impairment.
• Legal or regulatory changes, such as zoning restrictions, environmental requirements or new compliance costs may materially affect the project’s viability.
• Project abandonment or prolonged delays undermine the likelihood of generating expected cash flows that impact future value of the project.
• Cost overruns or tenant loss can erode profitability, making it unlikely the asset will recover its book value.

Together, these triggers highlight the need for timely reassessment to ensure financial statements reflect the true economic value of the development.

The Two-Step Impairment Test

1. Recoverability Test: Compare the carrying amount to the sum of undiscounted future cash flows. If the carrying amount exceeds the cash flows, proceed to step two.
2. Measurement of Impairment: Write down the asset to its fair value, typically based on discounted cash flows or market comparables.

Impairment losses are recognized in the income statement and cannot be reversed under GAAP, even if market conditions improve later.

Read “How to Know if Your Real Estate Entity Has Triggered an Impairment Loss” for a more detailed narrative on impairment.

Beyond the Basics: Strategic Accounting Considerations

Project Segmentation and Unit of Account

Should a mixed-use development be treated as one asset or multiple components, such as residential, retail or parking? This decision affects:

• Impairment testing
• Revenue recognition
• Cost allocation

Careful segmentation of projects helps achieve more accurate financial assessments and ensures business strategies are properly aligned. During this process, infrastructure and shared facilities are managed collectively so the overall project remains unified, even as each segment realizes its unique potential.

For example, when developing a multiuse project, the developer would begin by performing market and feasibility studies to gauge the demand for each use — such as residential, office, retail or hospitality. Based on those results, land or building space is divided into clearly defined parcels or components, each with specific design, financing and marketing approaches. Separate budgets and pro formas are set up for every segment, while leases or sales agreements are negotiated to fit the distinct needs of each part. Construction timelines are then coordinated to address the requirements of different users.

Revenue Recognition: Sales vs. Leasing

For projects intended for sale, ASC 606 governs revenue recognition. Developers must assess when control transfers to the buyer, which may involve:

• Performance obligations
• Variable consideration
• Complex contract terms

For leasing projects, ASC 842 applies. Developers must classify leases as operating or finance leases and recognize income accordingly.

Disclosures and Transparency

Investors, lenders and regulators demand transparency. Robust disclosures should include:

• Project status and milestones
• Capitalization policies
• Impairment risks
• Revenue recognition judgments

Public companies must also comply with Securities and Exchange Commission (SEC) guidance on Management Discussion and Analysis (MD&A) and risk factors, which increasingly emphasize forward looking risk disclosures.

Strategic Takeaways for Real Estate Stakeholders

To elevate accounting from a compliance function to a strategic advantage, real estate professionals should:

• Establish clear capitalization policies and train teams to apply them consistently.
• Monitor project timelines to ensure proper interest capitalization.
• Implement early warning systems for impairment triggers.
• Segment projects to reflect economic substance and support decision making.
• Maintain detailed documentation to support accounting judgments and withstand audit scrutiny.

Accounting as a Strategic Lever

In the world of real estate development, what’s on the books is just as important as what’s on the ground. Accounting decisions influence everything from investor confidence to tax efficiency and capital access. By mastering the intricacies of capitalization, interest and impairment, and by embracing transparency and strategic segmentation, developers and advisers can turn accounting into a competitive advantage.

As the regulatory landscape evolves and market volatility persists, the ability to tell a clear, credible financial story will separate the resilient from the rest. Whether you’re breaking ground on a new tower or advising clients through complex transactions, staying sharp on these principles isn’t just smart — it’s essential.

Contact Nick Antonopoulos or a member of your service team to discuss this topic further.

In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.