Section 174 R&D Expenditure Capitalization and Amortization

For tax years beginning after December 31, 2024, Section 174 R&D capitalization and amortization applies only to foreign research expenditures, which remain on a 15-year schedule. Domestic research or experimental costs are once again fully deductible in the year paid or incurred under new Section 174A, enacted by the One Big Beautiful Bill Act of 2025.¹ Businesses that capitalized domestic costs during 2022 through 2024 have several options for recovering the unamortized balances, and small businesses can go further and recover those costs retroactively by amending prior returns.

The Split Regime: Domestic vs. Foreign Research

The Tax Cuts and Jobs Act rewrote Section 174 for tax years beginning after December 31, 2021, requiring capitalization of all research expenditures over five years for domestic work and fifteen years for foreign work.² The OBBBA reversed that treatment for domestic costs starting with tax years beginning after December 31, 2024, and left foreign costs where TCJA put them.

Under Section 174A, a domestic research or experimental expenditure is deductible in full in the year it is paid or incurred.³ “Domestic” means any research expenditure not attributable to foreign research as defined in Section 41(d)(4)(F). If the research happens in the United States, the cost is deducted currently.

A taxpayer who prefers to spread the deduction can elect instead to capitalize domestic costs and amortize them over a period of at least 60 months, starting from the month the taxpayer first realizes benefits from the expenditures.¹ The election must be made by the return due date, including extensions, and is binding for that year and all later years unless the IRS approves a change. It can be useful for businesses sitting on net operating losses they don’t expect to absorb quickly.

Foreign research expenditures still must be capitalized and amortized over 15 years, beginning at the midpoint of the taxable year the costs are paid or incurred.² The midpoint convention gives you a half-year of amortization in year one, so a 15-year schedule with a half-year start actually spreads deductions across 16 returns.⁴

Location of the specific expenditure controls, not the residence of the taxpayer. A U.S. company paying a foreign lab to run experiments treats those payments as foreign research expenditures on the 15-year timeline, because contractor payments follow the location where the contractor performs the work. That single rule is a strong financial incentive to keep research operations in the United States.

What Counts as a Research or Experimental Expenditure

The definition applies across both Section 174 and Section 174A. Qualifying costs are tied to developing or improving a product, process, formula, or software, and the work must aim to eliminate uncertainty about the design, methodology, or capability of what you are building. Direct costs include wages for employees performing the research and materials consumed during experimentation. Indirect costs that directly support research activities also count: rent for lab space, utilities, insurance, equipment depreciation, maintenance, and security for facilities used in or directly supporting the research.⁴

Overhead from departments that only indirectly support the research stays out. Payroll staff cutting checks for researchers, HR handling research hires, and accounting tracking research budgets are not research expenditures, because those functions would exist regardless of the research activity.⁴ Whatever allocation method you use for the costs that do qualify must reflect a reasonable relationship between the cost and the research activity, and you have to apply it consistently.

All software development costs are treated as research or experimental expenditures, whether the software is built for sale to customers or for internal use.³ This statutory rule carries over into Section 174A and overrides older guidance that distinguished between internal-use and commercial software. Even failed projects generate research expenditures.

Section 174A does not apply to costs for acquiring or improving land, or for acquiring or improving depreciable property used in research. Those follow normal depreciation rules. Mineral exploration expenses are also excluded.³

Recovering Domestic Costs Capitalized in 2022 Through 2024

Businesses that capitalized domestic research costs during the TCJA years generally still carry unamortized balances into 2025. The OBBBA gives you three options for those balances:

Continue amortizing over the original five-year period.
Deduct the entire remaining balance in the first tax year beginning after December 31, 2024.
Spread the remaining balance ratably over two tax years.¹

Revenue Procedure 2025-28 provides the procedural detail. The transition to Section 174A treatment is made on a cut-off basis, meaning no Section 481(a) adjustment is required for prior expenditures. A change in the method for recovering unamortized TCJA-era amounts uses a separate designated change number. For both, the requirement to file a full Form 3115 is waived; a simplified statement attached to the return is sufficient.⁵

Small Business Retroactive Relief

Small business taxpayers that meet the Section 448(c) gross receipts test (average annual gross receipts of $31 million or less, computed for the first tax year beginning after December 31, 2024) get an additional option. They can elect to apply Section 174A treatment retroactively to domestic research costs paid or incurred in tax years beginning after December 31, 2021, and before January 1, 2025.⁵

To make the election, a qualifying taxpayer can either amend the returns for each affected year or file a change in accounting method. Amended returns must be filed by the earlier of July 6, 2026, or the deadline for filing a claim for credit or refund, which is generally three years from the date the return was filed. A small software company that capitalized $500,000 in developer salaries in 2022 and has deducted only a fraction so far can recover the difference as a refund by amending before that deadline.

Filing the Accounting Method Change

For the initial transition to Section 174A treatment in a tax year beginning after December 31, 2024, and before January 1, 2026, the IRS waived Form 3115. Attach a simplified statement to a timely filed return listing the taxpayer’s name, taxpayer identification number, the designated change number (273), and a declaration describing the new method.⁵ The change is made on a cut-off basis with no Section 481(a) adjustment.

For other Section 174-related method changes outside the initial transition window, the standard Form 3115 process applies. File the form in duplicate: the original attached to the timely filed federal income tax return (including extensions), and a signed copy mailed to the IRS National Office in Ogden, Utah. The duplicate copy must be sent no earlier than the first day of the year of change and no later than the date the original is filed with the return.⁶ Missing either copy can result in the IRS rejecting the change.

The IRS does not send a formal acknowledgment for automatic consent filings, so keep the supporting documentation clean: which costs qualify, where the research was performed, what allocation methods were used, and how amortization schedules were built. On examination, the IRS will look for ledgers tying specific expenditures to specific projects and locations.

Abandoned Projects Do Not Accelerate the Deduction

If property tied to capitalized research expenditures is disposed of, retired, or abandoned during the amortization period, the taxpayer must keep amortizing the costs on the original schedule.⁴ No write-off of the remaining unamortized balance is permitted, and that balance cannot be included in a gain or loss calculation on the disposition. Going forward, this rule bites hardest on foreign research and on any remaining TCJA-era domestic balances that a taxpayer has not yet chosen to accelerate under the transition rules.

A narrow exception applies when a corporation ceases to exist entirely through a liquidation or dissolution: the corporation can generally deduct all unamortized research costs in its final tax year, unless the IRS determines a principal purpose of the transaction was to accelerate that deduction.⁴ In a tax-free reorganization under Section 381(a), the acquiring corporation takes over the amortization schedule instead.

Interaction With the Section 41 Research Credit

Section 174/174A treatment and the Section 41 research credit run on parallel tracks. The first requirement for an expense to qualify for the Section 41 credit is that it could be treated as a research expenditure under Section 174 or Section 174A. The two provisions do different work: Section 174/174A governs how costs are recovered, while Section 41 provides a credit for performing qualifying research in the United States.

Section 280C prevents a double benefit by requiring a taxpayer who claims the Section 41 credit to reduce the amount of research expenditures deducted (or charged to a capital account) by the credit amount.¹ A taxpayer can elect under Section 280C(c)(2) to take a reduced credit instead, avoiding the deduction reduction. The election is made by the return due date (including extensions) and is irrevocable for that tax year. Most businesses run the numbers both ways.

The IRS has said that the TCJA capitalization changes and the OBBBA restoration are not intended to alter eligibility for the Section 41 credit. Revenue Procedure 2025-28 also lets small business taxpayers make late elections or revoke prior Section 280C(c)(2) elections for the applicable years, with a July 6, 2026 deadline.⁵

State Conformity Is a Separate Question

State income tax treatment does not automatically track the federal rules. Some states conform to Sections 174 and 174A as amended; others decoupled from the TCJA capitalization requirement during 2022 through 2024 and allowed immediate state-level expensing while federal law required amortization. Whether decoupled states will now re-conform after the OBBBA restoration is still moving in state legislatures.

Businesses operating in multiple states should review each state’s conformity status for every open year. A company that capitalized federally during 2022 through 2024 but expensed at the state level will face book-to-tax reconciliation differences on the way back to federal expensing, and the interaction between state conformity dates, the OBBBA effective date, and the small business retroactive rules can produce complex multi-state filings.

1
Congress.gov. H.R.1 – 119th Congress – One, Big, Beautiful Bill Act – Section 70302
2
Office of the Law Revision Counsel. 26 USC 174 – Amortization of Research and Experimental Expenditures
3
Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
4
Internal Revenue Service. Notice 2023-63 – Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
5
Internal Revenue Service. Revenue Procedure 2025-28
6
Internal Revenue Service. Instructions for Form 3115 – Application for Change in Accounting Method