How to Depreciate Software for Tax Purposes

To depreciate software for tax purposes, you generally write off purchased off-the-shelf software over 36 months on a straight-line basis, but you can often deduct the entire cost in year one using Section 179 or 100 percent bonus depreciation. Software you develop in-house follows a separate track under Section 174A, and cloud subscriptions aren’t depreciated at all. Which path fits depends on how you acquired the software, whether you built it yourself, and how much other equipment you bought that year.

The Default 36-Month Write-Off

Section 167(f)(1) sets the standard recovery period for computer software at 36 months, straight-line.¹ Divide the total cost by three for your annual deduction, and prorate the first year by the number of months the software was in service.

This treatment applies to off-the-shelf software, which the code defines by three tests: it’s readily available for purchase by the general public, it’s sold under a nonexclusive license, and it hasn’t been substantially modified.² Custom software you hire a developer to build also qualifies for the 36-month period, provided you didn’t acquire it as part of buying a whole business.

Your cost basis includes everything spent getting the software running: purchase price, sales tax, installation, and testing. Salvage value is almost always zero, so you write off the full amount. The clock starts the month the software is placed in service, meaning installed, tested, and ready for its intended use.

Section 179: Full Cost in Year One

Section 179 lets you deduct the entire cost of qualifying software the year you place it in service. For 2026, the maximum deduction is $2,560,000, with a phase-out that starts once total qualifying property purchases for the year exceed $4,090,000.³ Above that ceiling, the deduction drops dollar-for-dollar to zero.

To qualify, the software must be off-the-shelf, purchased for use in the active conduct of your business, and used more than 50 percent of the time for business.³ If business use later drops to 50 percent or below, expect to recapture part of the deduction.

One catch: a Section 179 deduction can’t create or increase a net operating loss. Your deduction is capped at your business’s taxable income for the year, and any excess carries forward. For a single $5,000 license, this rarely bites. For businesses combining software with heavier equipment spending near the phase-out threshold, the math matters.

Bonus Depreciation

Computer software is listed as qualified property under Section 168(k), which makes it eligible for bonus depreciation separately from Section 179.⁴ The One Big Beautiful Bill Act, enacted in mid-2025, permanently restored 100 percent bonus depreciation for eligible property acquired after January 19, 2025.⁵ Software placed in service in 2026 can be fully deducted the year it’s put to work.

Bonus depreciation has two advantages over Section 179. There’s no dollar cap, and it can create or increase a net operating loss that carries to other years. It also doesn’t require more than 50 percent business use, though the deductible amount is limited to the business-use percentage. The trade-off is that bonus depreciation is all-or-nothing for a given class of property in a given year. You can elect out, but the election covers every asset in the same class, not individual items.

If a smaller first-year deduction fits your income planning better, you can elect 40 percent bonus depreciation instead of the full 100 percent for the first taxable year ending after January 19, 2025.

Software You Develop In-House

Software your business develops internally or pays contractors to build follows a separate set of rules. Before 2022, most businesses deducted these costs immediately as research and experimental expenditures under Section 174. The Tax Cuts and Jobs Act forced capitalization and amortization over five years for domestic research and 15 years for foreign research.⁶

The One Big Beautiful Bill Act reversed this for domestic research. Under new Section 174A, businesses can again immediately deduct domestic software development costs for tax years beginning after December 31, 2024. Full expensing is available for 2025 and 2026 returns. Alternatively, you can elect to capitalize those costs and amortize them over at least 60 months if spreading the deduction serves your tax situation better.

Foreign development costs remain on the 15-year amortization track from the TCJA. If your company outsources development overseas, those expenditures must be capitalized and written off over 15 years starting the month the research benefits your business. The distinction turns on where the research is physically performed, not where your company is headquartered.

Not every software-related cost counts as development. Quality-control testing, training, data conversion, and installation are excluded.⁷ Qualifying costs are limited to activities that resolve genuine technical uncertainty about the software’s design, capability, or method of development. Once the software is placed in service, further spending falls outside Section 174.

SaaS and Subscription Software

Cloud-based software you access through a subscription isn’t depreciated. When you pay for a SaaS product like a monthly CRM or project management tool, you’re paying for access, not acquiring an asset. Subscription fees are ordinary business expenses deductible in the year paid, the same as rent or utilities.

Ownership is the line. A perpetual license to software installed on your systems is a depreciable asset. A recurring fee to use someone else’s software on their servers is not. The shift toward subscription pricing means many businesses have fewer software assets on their depreciation schedules and more deductible operating expenses.

Implementation is a middle case. Setup and configuration costs for a cloud platform may need to be capitalized and amortized over the subscription term, while preliminary planning and post-launch training are expensed immediately. If your vendor bundles implementation with the subscription fee, you’ll need to allocate the charge between the components based on each one’s standalone value.

Software Acquired With a Business

Software bundled into the purchase of a company or a substantial portion of its assets follows different rules. If goodwill or going-concern value attaches to the transaction, the software falls under Section 197 and must be amortized straight-line over 15 years.² That’s five times the standard recovery period, and it catches business buyers off guard.

The distinction is contextual. The same accounting program that would be a 36-month asset if bought on its own becomes a 15-year asset when it comes in with goodwill.⁸ If your purchase agreement separates the software from the business’s goodwill and it qualifies as off-the-shelf, you may be able to argue for the shorter period. Getting the allocation right in the purchase agreement matters here.

Reporting on Form 4562

Whatever method you use, you report it on Form 4562, Depreciation and Amortization.⁹ The form separates the methods:

Part I is for Section 179 elections. List the software, its cost, and the amount you’re electing to expense.
Part II is for bonus depreciation (the special depreciation allowance). Enter the cost of qualifying property.
Part VI is for amortization. This is where 36-month software under Section 167(f)(1) and 15-year Section 197 software are reported.

You’ll need the software’s cost basis, the date it was placed in service, the method, and the recovery period. The form instructions walk through each column.¹⁰ Form 4562 attaches to your main tax return, and the totals need to flow correctly to the depreciation line of whatever return you file.¹¹

Records and Penalty Exposure

Keep depreciation records for as long as you own the software plus the statute of limitations period after you dispose of it.¹² The standard limitations period is three years from filing. That’s roughly six years for 36-month software and closer to 18 for Section 197 software amortized over 15 years. Retain the purchase invoice, license agreements, installation documentation, the in-service date, and, if you claimed Section 179 or bonus depreciation, proof the software met the eligibility rules including business-use percentage.¹⁰

Overstating cost basis or claiming the wrong recovery period can trigger accuracy-related penalties. If the IRS finds your claimed basis was 150 percent or more of the correct amount, you face a 20 percent penalty on the resulting underpayment. At 200 percent or more, the penalty doubles to 40 percent. A substantial understatement of income tax, generally more than the greater of 10 percent of the tax owed or $5,000, also triggers the 20 percent penalty.¹³ The mistakes that most often lead to trouble: claiming 36-month treatment on software that should be a 15-year Section 197 asset, expensing development costs that don’t meet the technical-uncertainty test, and treating personal-use software as a business expense.

1
Office of the Law Revision Counsel. 26 USC 167 Depreciation
2
Office of the Law Revision Counsel. 26 USC 197 Amortization of Goodwill and Certain Other Intangibles
3
Office of the Law Revision Counsel. 26 USC 179 Election to Expense Certain Depreciable Business Assets
4
Office of the Law Revision Counsel. 26 USC 168 Accelerated Cost Recovery System
5
Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill
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Internal Revenue Service. Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
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eCFR. 26 CFR 1.174-2 Definition of Research and Experimental Expenditures
8
eCFR. 26 CFR 1.197-2 Amortization of Goodwill and Certain Other Intangibles
9
Internal Revenue Service. About Form 4562, Depreciation and Amortization (Including Information on Listed Property)
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Internal Revenue Service. 2025 Instructions for Form 4562
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Internal Revenue Service. Publication 946 (2025), How To Depreciate Property
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Internal Revenue Service. How Long Should I Keep Records
13
Office of the Law Revision Counsel. 26 USC 6662 Imposition of Accuracy-Related Penalty on Underpayments