How research and software development spend is deducted

What is it?

Before 2022, research and experimental costs — a category that includes most software development — could generally be deducted in full in the year they were incurred. A business writing code or developing a product recovered that spending immediately, matching the deduction to the cash outlay.

For tax years beginning after 2021, the Tax Cuts and Jobs Act reversed that. It required these costs to be capitalized and amortized over a period of years rather than deducted at once, with a longer period for research performed outside the United States. Overnight, businesses that had been deducting development spending had to spread it out, which for many raised taxable income sharply even in years when cash was going out the door.

For tax years beginning after 2024, the One Big Beautiful Bill Act reversed course again for domestic work: research and experimental costs incurred in the United States can once more be deducted immediately, while costs of research performed abroad remain subject to amortization. The Act also provided ways to unwind the interim capitalization — including a retroactive election for some businesses and a catch-up of previously capitalized domestic costs — with the mechanics differing by the size of the business.

The practical upshot is that the correct answer depends on which tax year you are looking at and where the work was done. A business amending or revisiting a return for an interim year follows the capitalization rule, while a business planning current spending follows the restored immediate-deduction rule for its domestic work and continues to amortize its foreign work.

Who does it apply to?

Businesses that incur research, experimental, or software development costs, whether performed in-house or through contractors.

Companies revisiting returns for tax years in the interim period, who may be able to change their treatment or catch up previously capitalized domestic costs.

Businesses planning current and future development budgets that need to separate domestic spending from foreign spending, which are still treated differently.

Who does it not work for?

• Ordinary operating costs that are not research or experimental — routine data entry, marketing, general administration, and the like — which are deducted under their own rules regardless of these provisions.
• Costs of research performed outside the United States, which remain subject to amortization and do not qualify for the restored immediate deduction.
• Land and depreciable property used in research, along with the acquisition or improvement of such property, which are recovered through depreciation rather than as research costs.
• Costs already fully recovered under a prior year's method where no permitted election or accounting-method change is available to revisit them.

What does the IRS look at?

• Whether costs claimed as research or experimental genuinely fall within that category rather than being ordinary business expenses.
• Whether domestic and foreign research costs are correctly separated, since only domestic costs qualify for immediate deduction.
• Whether the correct treatment was applied for each specific tax year, given how the rule changed across periods.
• Whether any retroactive election or catch-up of previously capitalized costs was made through the proper procedure and within its deadline.
• Whether the treatment of these costs is consistent with any research credit claimed on the same activities.

What does it cost to fund, and when does the window close?

There is no cash outlay to fund; the cost is the accounting and analysis needed to classify spending correctly and to apply the right rule to each year. Because the provision changed retroactively, revisiting interim years can require an accounting-method change or an amended return, each with its own procedure.

A CPA identifies which costs are research or experimental, separates domestic from foreign spending, and determines whether a retroactive election or catch-up is available and worthwhile for your business size. Where a change is made, it is filed through the applicable method-change or election procedure, so the timing and paperwork should be planned rather than left to filing season.

Related strategies

• §41The research and development creditNo outlay
• §446Which year income and deductions land inNo outlay
• §481Catching up missed depreciation without amendingNo outlay

Common questions

Is software development treated as a research cost?

Generally yes. Software development costs have long been treated as research or experimental expenditures, so they followed every swing in that rule: immediate deduction before 2022, mandatory capitalization and amortization for tax years beginning after 2021, and restored immediate deduction for domestic work in the current rule. Classification is not automatic for every project, because work that is really configuration, data entry, or routine maintenance sits outside the category. How a specific development effort is characterised should be confirmed for the tax year in question.

I capitalized these costs in an earlier year. Can I fix that?

Possibly. The current law provides routes to unwind interim capitalization of domestic research costs, including a retroactive election available to some businesses and a catch-up of amounts previously capitalized, and which route is open depends on the size of the business and the years involved. Each route runs through its own procedure and deadline, whether an amended return or a change in accounting method filed on Form 3115. A CPA should confirm which procedure applies before anything is filed, because using the wrong one can forfeit the benefit for that year.

Does it matter where the research is done?

Very much. Under the current rule, research and experimental costs incurred in the United States can be deducted in the year incurred, while costs of research performed outside the United States must still be capitalized and amortized over a period of years. A business using offshore contractors or a foreign development team therefore has to track spending by where the work is performed, not only by project. Without that split, the return either overstates the immediate deduction or gives up part of it.

Mena Hemaia, CPA, CIA

Chief Executive Officer, Accountack — West Palm Beach, Florida

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