IRC Section 174 R&E Expenditures: Capitalization vs Immediate Expensing

For tax years beginning after 2021, the Tax Cuts and Jobs Act (TCJA) required businesses to capitalize research or experimental (R&E) expenditures and amortize them over five years for domestic research and fifteen years for foreign research. That rule created large book-tax differences for software and product companies, and many clients carried deferred tax assets for capitalized R&E. P.L. 119-21, the One Big Beautiful Bill Act (OBBBA), enacted July 4, 2025, restored domestic expensing through a new section 174A and left foreign research under section 174. This page summarizes the rules from IRS Revenue Procedure 2025-28, the transition elections, and what to check in an audit or review. For deferred tax mechanics, see ASC 740 for private companies.

This page summarizes IRS guidance. It is not tax advice.

What does section 174A allow?

Under Rev. Proc. 2025-28, section 174A allows a deduction for domestic research or experimental expenditures paid or incurred in taxable years beginning after December 31, 2024. A taxpayer can instead elect under section 174A(c) to charge the expenditures to a capital account and amortize them ratably over a period of not less than 60 months, beginning with the month in which the taxpayer first realizes benefits from the expenditures.

Domestic research excludes research attributable to foreign research within the meaning of section 41(d)(4)(F). Foreign R&E stays under section 174, which still requires capitalization and ratable amortization over 15 years beginning at the midpoint of the taxable year in which the expenditures are paid or incurred. The OBBBA also provides that if property tied to foreign R&E is disposed of, retired or abandoned, the amortization deduction continues rather than being accelerated. That applies to dispositions after May 12, 2025.

The 2022 to 2024 rules, for reference: domestic SRE expenditures were amortized over five years and foreign over 15 years, each beginning at the midpoint of the taxable year. Software development costs have been treated as R&E since 2022, with the scope addressed in IRS Notice 2023-63.

What are the transition options?

Rev. Proc. 2025-28 explains three paths for domestic R&E capitalized in 2022 through 2024.

1. Recover the remaining balance in the first year or over two years. A taxpayer may elect to deduct any remaining unamortized domestic amount in full in the first taxable year beginning after December 31, 2024, or ratably over the two-taxable-year period beginning with that year. This is treated as a change in method of accounting, made on Form 3115 under the automatic consent procedures, and the revenue procedure sets the statement a taxpayer attaches.
2. Do nothing. Continue amortizing the remaining balance on the original schedule.
3. Small business retroactive election. A small business taxpayer could elect to apply section 174A to amounts paid or incurred in taxable years beginning after December 31, 2021, instead of after December 31, 2024, generally by amending returns. Small business here means a taxpayer meeting the section 448(c) gross receipts test for its first taxable year beginning after December 31, 2024. The test is average annual gross receipts for the three prior taxable years of $25,000,000 or less, adjusted for inflation, which Rev. Proc. 2025-28 puts at $31,000,000 for a taxable year beginning in 2025. The statutory deadline for this election was one year after enactment, July 4, 2026, so for most clients the window has closed.

The revenue procedure also provides an automatic extension for certain 2024 returns filed before September 15, 2025 to file superseding returns applying its provisions.

Worked illustration

Illustrative numbers. A calendar-year company capitalized $1,000,000 of domestic R&E in 2023 and nothing else in the period.

• 2023 amortization with midpoint convention: $1,000,000 / 5 x 0.5 = $100,000
• 2024 amortization: $1,000,000 / 5 = $200,000
• Unamortized balance at December 31, 2024: $1,000,000 - $100,000 - $200,000 = $700,000

For 2025 the company may elect to deduct the full $700,000, or $350,000 in each of 2025 and 2026, or continue the original schedule of $200,000 in 2025. New domestic R&E of $400,000 paid in 2025 is deductible in 2025 under section 174A(a), or amortizable over at least 60 months if the company elects that route.

Deferred taxes at a 25 percent rate. At December 31, 2024 the company carried a deferred tax asset of $700,000 x 0.25 = $175,000. If it elects to deduct the full balance in 2025, the asset reverses in 2025 through deferred tax expense and the benefit shows up as a lower current tax payable.

What does this mean for the financial statements?

A change in tax law is recognized in the period it is enacted, and the enactment date for the OBBBA is July 4, 2025. For a calendar-year client, the effect of the law on the deferred tax asset for capitalized R&E is a 2025 item, recognized through income tax expense. The accounting for the transition election itself depends on what the client files. Work through the following.

• Deferred tax asset for capitalized R&E. Roll it forward from the December 31, 2024 balance. Compare it to the tax return and Form 3115 elections actually filed.
• Current versus deferred split. A large 2025 deduction from the transition election lowers current tax. The offset is deferred tax expense as the asset reverses.
• Valuation allowance. Clients that carried a valuation allowance against the R&E asset should reassess it with the new reversal pattern.
• State conformity. States differ on whether they follow section 174A. State deferred taxes and the rate reconciliation may differ from federal.
• Credit interactions. The research credit and the section 280C election interact with R&E treatment. Rev. Proc. 2025-28 describes late section 280C(c)(2) elections for eligible small business taxpayers.
• Books are separate. For financial reporting, research and development costs are expensed as incurred under ASC 730 whatever the tax rule. Tax treatment affects only the deferred and current tax accounts.

See the income tax provision workbook and the deferred tax rollforward and valuation allowance template.

Common problems

Practice observations, not requirements:

• A client that never set up a section 174 schedule for 2022 to 2024 because the preparer used a software default, leaving no support for the opening balance.
• Payroll, contractor and cloud costs allocated to R&E on a rough percentage with no documentation of the projects.
• Foreign contractor costs not separated from domestic ones.
• The transition election assumed without a Form 3115 on file.
• The 2025 provision still showing the old schedule because it was prepared before the Act.

FAQ

Is domestic R&E now deductible in the year paid?

Yes, for amounts paid or incurred in taxable years beginning after December 31, 2024, under section 174A(a), unless the taxpayer elects under section 174A(c) to capitalize and amortize over at least 60 months.

What happens to foreign research costs?

They remain under section 174, capitalized and amortized over 15 years beginning at the midpoint of the taxable year.

How is the 2022 to 2024 capitalized balance recovered?

The taxpayer may deduct the remaining balance in the first year beginning after December 31, 2024 or over two years, by election, or leave it on the existing schedule. The election is an automatic change in accounting method.

Does this change the audit of R&D costs under GAAP?

No. GAAP expensing of R&D under ASC 730 is unchanged. The audit effect is in income tax expense, deferred taxes and the rate reconciliation.

Sources

• IRS, Revenue Procedure 2025-28 (Internal Revenue Bulletin 2025-38), sections 2, 3 and 7: https://www.irs.gov/pub/irs-drop/rp-25-28.pdf
• Public Law 119-21, section 70302 (domestic research or experimental expenditures), as described in Rev. Proc. 2025-28
• KPMG, Handbook: Accounting for Income Taxes (2025), discussion of ASC 740-10-25-47 (effect of enacted tax law changes)

Related

• Bonus depreciation and section 179
• ASC 740 income taxes for private companies
• Income tax provision workbook
• Deferred tax rollforward and valuation allowance
• ASU 2023-09 income tax disclosures
• Audit program for income taxes

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error