Taxpayers subject to section 263A must capitalize all direct costs and certain indirect costs properly allocable to property produced….” 26 C.F.R. § 1.263A-1(e)(1). Direct costs consist primarily of materials and labor, id. § 1.263A-1(e)(2). As to indirect costs, the regulation states the following:
Indirect costs are defined as all costs other than direct material costs and direct labor costs (in the case of property produced) . . . . Taxpayers subject to section 263A must capitalize all indirect costs properly allocable to property produced. . . . Indirect costs are properly allocable to property produced . . . when the costs directly benefit or are incurred by reason of the performance of production . . . activities. Indirect costs may be allocable to . . . other activities that are not subject to section 263A. Taxpayers subject to section 263A must make a reasonable allocation of indirect costs between production . . . and other activities. Id. § 1.263A-1(e)(3)(i).
