Section 174 Tax: 2025 R&E Expensing and Amortization Rules

Section 174 tax rules changed significantly for tax years beginning after December 31, 2024. Domestic research and experimental (R&E) costs are once again fully deductible in the year you pay or incur them, under a new Section 174A created by the One Big Beautiful Bill Act (OBBBA).¹ Foreign R&E costs still fall under the amended Section 174 and must be capitalized and amortized over 15 years.² Where the research physically happens now drives the tax treatment.

What Changed for 2025

The Tax Cuts and Jobs Act (TCJA) had forced businesses to capitalize all R&E costs starting with tax years beginning after December 31, 2021, amortizing them over five years for domestic research and fifteen years for foreign research.³ That rule squeezed cash flow for companies with heavy R&D spending, because a $500,000 outlay produced only a fraction of a deduction in year one.

The OBBBA, enacted in mid-2025, split the treatment. New Section 174A handles domestic R&E and restores immediate deductibility. The original Section 174 was narrowed to cover only foreign R&E, which stays on the 15-year schedule. The change applies to amounts paid or incurred in tax years beginning after December 31, 2024, so 2025 returns are the first to benefit.⁴

Domestic R&E Under Section 174A

Any domestic R&E expenditure you pay or incur in a tax year beginning after December 31, 2024 is deductible that same year. No amortization schedule, no multi-year tracking.¹ “Domestic” means the research was performed inside the United States, Puerto Rico, or a U.S. possession. Everything else is foreign research.

You can elect a different path. Section 174A(c) lets you capitalize domestic R&E costs and amortize them over a period of at least 60 months, starting the month you first realize benefits from the expenditures.¹ This mostly appeals to startups that don’t yet have enough taxable income to absorb a large single-year deduction.

The election is made by the filing deadline, including extensions, for the tax year in question, and once made it locks you in for that year and later years unless the IRS approves a change.¹

Foreign R&E Under Section 174

Research conducted outside the United States remains under Section 174 and must be capitalized and amortized over 15 years. A mid-year convention applies: amortization begins at the midpoint of the tax year in which you pay or incur the cost, regardless of when during that year the spending actually occurs.² For a full 12-month year, that midpoint is the first day of the seventh month.

A calendar-year company that pays $1.5 million for offshore software development in March gets the same first-year deduction as one that pays in November. Annual amortization is $100,000 ($1.5 million divided by 15). The first-year deduction is half of that, or $50,000, because of the mid-year convention. Years two through fifteen carry the full $100,000, with another half-year amount in the final year.

The domestic/foreign split matters. Paying a contractor in Canada to build and test a prototype gets you 15-year amortization. Paying an equivalent contractor in Texas for the same work gets you an immediate deduction.

Catching Up on 2022–2024 Capitalized Costs

If your business capitalized domestic R&E costs during the TCJA years and still carries an unamortized balance, the OBBBA gives you two ways to recover it. You can elect to deduct the entire remaining unamortized amount in your first tax year beginning after December 31, 2024, or you can spread that balance over two years starting with the same tax year.⁴

The IRS treats this as a change in accounting method initiated by the taxpayer with the Secretary’s consent, applied on a cut-off basis. No Section 481(a) adjustment is allowed for domestic R&E expenditures paid or incurred in tax years beginning after December 31, 2024.⁴ So if you capitalized $2 million in domestic R&E between 2022 and 2024 and $1.4 million remains unamortized, you can claim that full $1.4 million on your 2025 return, or split it between 2025 and 2026.

What Counts as an R&E Expenditure

Both Section 174 and Section 174A apply to costs tied to your trade or business that represent research and development in the experimental sense. The IRS reads this broadly: it covers costs of developing or improving a product, a component of a product, or a formula, invention, or pilot model.³ Common qualifying costs include:

Wages, salaries, and benefits for engineers, scientists, and researchers directly involved in experimental work.
Materials and supplies consumed during testing, prototyping, and experimentation.
Legal fees and other costs incurred to obtain a patent on developed technology.³
Any amount paid or incurred to develop software, whether for sale to customers or internal use.⁵
A portion of rent, utilities, insurance, repairs, and depreciation on property used in R&E activities.

Notice 2023-63 clarified that certain indirect overhead costs must be allocated to R&E using reasonable cause-and-effect factors. If your lab occupies 30% of a building, roughly 30% of that building’s rent and utilities may need to be treated as R&E costs. General and administrative costs from departments like payroll, human resources, and accounting are explicitly excluded and do not need to be allocated.

Costs that don’t involve discovering new information or eliminating technical uncertainty don’t qualify. Routine quality control, market research, and management studies remain ordinary business expenses deductible under Section 162. Getting the line right matters in both directions: lumping ordinary expenses into your R&E bucket creates problems if you’re capitalizing foreign costs, and failing to identify a genuine R&E cost can mean overpaying.

Software Development

Software development is treated as an R&E expenditure by statute.⁵ Domestic software development is deducted immediately under Section 174A. Foreign software development is subject to 15-year amortization. A company that offshores application development to save on labor should factor the slower tax recovery into the comparison.

Contract Research

When you hire a third party to perform research, who capitalizes or deducts the costs depends on financial risk and intellectual property rights. Under IRS guidance, a service provider treats its own costs as R&E expenditures only if it bears financial risk related to the research’s failure or retains the right to exploit the results in its own trade or business. If the contractor has no financial risk and no meaningful IP rights, the party paying for the research and holding the rights treats the costs as its own R&E expenditures.

The Abandonment Trap for Foreign Projects

Section 174(d) delivers an unwelcome surprise for companies that shut down capitalized projects. If you abandon, retire, or dispose of property connected to capitalized R&E expenditures, you cannot claim an immediate loss deduction for the unamortized balance. The amortization schedule keeps running as if nothing happened.³ For events after May 12, 2025, you also can’t reduce the amount realized on a disposition by the unamortized costs.

This mostly bites companies with foreign R&E, since domestic costs are now deducted immediately and don’t leave a lingering balance. Spend $3 million on an offshore research project in 2025 and scrap it in 2026, and you continue amortizing that $3 million across the remaining years of the 15-year schedule.

Interaction With the Section 41 R&D Credit

Section 174 and Section 41 cover overlapping but distinct territory. Section 174 (and now 174A) governs how you deduct or amortize R&E costs. Section 41 provides a separate tax credit for increasing research activities. A cost can qualify for both.⁶

You can’t have the full deduction and the full credit on the same dollar. Under Section 280C, claiming the R&D credit requires reducing your R&E deduction (or capitalized amount) by the amount of the credit. Alternatively, you can make an irrevocable election under Section 280C(c)(2) to claim a reduced credit and keep the full deduction.⁶ Which is better depends on your marginal tax rate and the credit amount, so run the math both ways.

Skipping the Section 41 credit doesn’t excuse you from correctly classifying expenses under Section 174 or 174A. The classification obligation exists regardless.

Records and Forms

For domestic R&E deducted immediately, you still need to document what qualifies as R&E versus ordinary business expense. For foreign R&E on the 15-year amortization schedule, the documentation burden is heavier because the schedule runs for a decade and a half. Records worth keeping include:

Payroll records with time allocation showing the percentage of time each employee spends on qualifying R&E, supported by time-tracking software or project management logs.
Overhead allocation workpapers justifying how you attributed portions of rent, utilities, and other indirect costs to R&E.
Receipts and invoices for materials, supplies, and third-party contractor costs, organized by tax year.
Geographic sourcing records establishing where research was conducted, since domestic-versus-foreign classification drives the tax treatment.

Report amortization for foreign R&E expenditures on Form 4562.⁷ Claim the Section 41 credit on Form 6765.⁶ Businesses changing accounting method to adopt Section 174A treatment for previously capitalized domestic costs should follow the automatic consent procedures in Rev. Proc. 2025-28.⁴

Corporate filers attach these forms to Form 1120 or Form 1120-S. Sole proprietors and partnerships include them with Form 1040 and related business attachments. Keep supporting workpapers for at least seven years, since the IRS statute of limitations extends that far for certain loss-related claims.⁸ For foreign R&E, keeping records for the full 15-year amortization period plus three years is safer.

State Tax Considerations

State treatment doesn’t automatically match the federal rules. During the TCJA capitalization period from 2022 through 2024, roughly 10 states continued to allow immediate expensing, either by decoupling legislation or by conforming to a pre-TCJA version of the Internal Revenue Code. With federal law now restoring immediate deductibility for domestic costs, most states that conform to the current IRC will follow. States that selectively decouple may have their own timelines. Check your state’s conformity status before filing, particularly if you have R&E costs across multiple states.

1
Office of the Law Revision Counsel. 26 USC 174A – Domestic Research or Experimental Expenditures
2
Office of the Law Revision Counsel. 26 US Code 174 – Amortization of Research and Experimental Expenditures
3
Internal Revenue Service. Notice 2023-63 – Guidance on Amortization of Specified Research or Experimental Expenditures Under Section 174
4
Internal Revenue Service. Rev Proc 2025-28 – Guidance on Section 174A and Amended Section 174
5
Office of the Law Revision Counsel. 26 US Code 174 – Amortization of Research and Experimental Expenditures – Section 174(c)(3)
6
Internal Revenue Service. Instructions for Form 6765 – Credit for Increasing Research Activities
7
Internal Revenue Service. Instructions for Form 4562 – Depreciation and Amortization
8
Internal Revenue Service. How Long Should I Keep Records