Internal Revenue Code Section 174: 174A Domestic, Foreign R&E, Cleanup

Section 174 of the Internal Revenue Code sets the capitalization and amortization rules for research and experimental expenditures, and those rules split cleanly in two as of 2025. Domestic R&E is fully deductible in the year paid or incurred under new Section 174A, added by the One Big Beautiful Bill Act signed on July 4, 2025 and effective for tax years beginning after December 31, 2024. Foreign R&E stays under amended Section 174 and must be capitalized and amortized over 15 years. The transition years 2022 through 2024, when all R&E had to be capitalized, still matter for anyone cleaning up prior returns.¹

What Counts as an R&E Expenditure

R&E expenditures are costs connected to your trade or business that represent research and development in the experimental or laboratory sense. The IRS defines them broadly as costs tied to developing or improving a product, including formulas, inventions, techniques, patents, and pilot models.²

The defining feature is uncertainty. The work must aim to resolve technical uncertainty about whether a product can be developed, how to develop it, or what the right design looks like. If you already know the answer before you spend the money, the cost is not R&E. Qualifying costs typically include wages and salaries for employees performing or supervising the research, materials and supplies consumed during the work, and a reasonable share of overhead directly tied to the research activities.

Several categories look research-adjacent but do not qualify. Quality control testing of finished products, efficiency surveys, management studies, consumer research, and advertising are all excluded.³⁴ Production costs incurred after the uncertainty has been resolved are ordinary business expenses or inventory costs, not R&E.

Domestic R&E Under Section 174A

For tax years beginning after December 31, 2024, Section 174A allows any taxpayer to deduct domestic R&E in full in the year the costs are paid or incurred.⁵ The provision is permanent, and it applies regardless of company size.

Domestic means any R&E expenditure that is not attributable to foreign research as defined in Section 41(d)(4)(F). In practice, the research activities must be performed within the United States, the District of Columbia, or Puerto Rico.

Immediate expensing is the default, but Section 174A gives taxpayers two alternatives if capitalizing the costs suits their situation better. Under Section 174A(c), a taxpayer can elect to capitalize domestic R&E and amortize it over at least 60 months starting from the month the taxpayer first realizes benefits from the research. Conforming amendments to Section 59(e) also allow domestic R&E to be deducted ratably over 10 years, beginning with the year the expenditures were made. Both elections are uncommon; they mainly help startups or companies with net operating losses that cannot use a large current-year deduction.

Foreign R&E Under Section 174

Foreign R&E did not get the same relief. Amended Section 174 now applies exclusively to foreign research costs, which must be capitalized and amortized over a 15-year period beginning at the midpoint of the tax year in which the expenditures are paid or incurred.¹ Amortization is mandatory. There is no election to expense.

How the Half-Year Convention Works

Amortization begins at the midpoint of the tax year regardless of when during the year the costs were incurred. Take a calendar-year taxpayer that spends $150,000 on foreign research in 2026. The annual amortization amount is $10,000. The first-year deduction is $5,000, full $10,000 deductions run in years two through 15, and the final $5,000 falls in year 16. The 15-year schedule stretches across 16 taxable years.

Disposition Does Not Accelerate the Deduction

If property connected to foreign R&E is sold, abandoned, or retired before the amortization period ends, the remaining unamortized costs cannot be deducted as a loss or used to reduce the amount realized on the sale. The schedule continues as originally set.¹ Businesses must keep tracking the unamortized balance even after abandoning the underlying project.

Allocating Costs Between Domestic and Foreign

The domestic-foreign split now carries more weight than it did under the original TCJA rules, because one side is fully deductible and the other is locked into 15 years. Allocation follows where the research activities are physically performed, not where the results are used or where the company is headquartered. When a single project involves researchers in the U.S. and abroad, the costs must be split on a reasonable basis, such as direct labor costs attributable to each location.

Once a taxpayer adopts an allocation method, it becomes an accounting method that must be applied consistently. Switching to a different approach later requires filing Form 3115 to request the IRS’s consent.⁶

Software Development

Software development is one of the most common triggers for Section 174 treatment. Planning, designing, coding, testing, and documenting new or significantly improved software functionality qualifies as R&E when the work involves genuine technical uncertainty. For 2026 filers, domestically developed software costs are fully deductible under Section 174A. Software developed by foreign teams or at foreign facilities falls under the 15-year foreign amortization rule. Companies with globally distributed engineering teams have to track developer hours by location to allocate correctly.

Routine maintenance, bug fixes, and adapting existing software to run on new hardware generally lack the uncertainty needed to qualify. Those costs are ordinary business expenses or are capitalized under Section 167 or Section 263(a), depending on the circumstances. Off-the-shelf software or software not acquired as part of a business purchase is typically excluded from Section 197 amortization and recovered under other provisions.⁷

Contract and Funded Research

When one company hires another to perform research, the treatment turns on who bears the economic risk and who owns the results.

If you pay a third party a fixed fee to conduct research on your behalf, you bear the risk. The costs are your R&E expenditures. The contractor treats its own costs as ordinary business expenses deductible under Section 162, because it has no financial stake in whether the research succeeds. The amortization period, or immediate deductibility, then depends on where the contractor physically performs the work. A U.S.-based lab produces domestic R&E deductible under Section 174A. Overseas work produces foreign R&E amortized over 15 years. What matters is where the work happens, not where the invoice comes from.

The analysis changes when the performer keeps rights to use or exploit the resulting intellectual property. Under Notice 2024-12, a research provider that holds an “SRE product right” must treat its costs of performing the research as its own R&E expenditures subject to capitalization, even if it does not bear the financial risk of the project.⁸ An SRE product right means the provider can use, sell, lease, or license the results in its own business. Access that requires another party’s approval does not count.

Buying a finished patent, trade secret, or other completed intellectual property is not an R&E expenditure at all. The purchase price is typically capitalized under Section 197 and amortized over 15 years as an acquired intangible asset.⁷ Paying someone while research is ongoing creates an R&E expenditure; paying for the finished result creates a Section 197 asset.

Cleaning Up 2022 Through 2024

Between 2022 and 2024, all R&E had to be capitalized. Domestic costs were amortized over five years and foreign costs over 15, both using the half-year convention. A calendar-year taxpayer that spent $100,000 on domestic R&E in 2022 would deduct $10,000 that year, $20,000 per year from 2023 through 2026, and a final $10,000 in 2027. For businesses that have not amended their returns, those schedules are still running.

Retroactive Election for Small Businesses

The OBBBA gave eligible small businesses a chance to undo the 2022-2024 capitalization. Taxpayers with average annual gross receipts of $31 million or less, measured using the Section 448(c) test for the first tax year beginning after December 31, 2024, can elect to apply Section 174A retroactively to all tax years beginning after December 31, 2021.⁹

The election is made by filing amended returns or administrative adjustment requests for each affected tax year. The deadline is the earlier of July 6, 2026, or the expiration of the statute of limitations for a given year. For a 2022 return filed on time in April 2023, the three-year refund window closes in April 2026, before the July deadline. Small businesses that want this relief should move quickly.

As an alternative to amending each year, a small-business taxpayer can make an automatic accounting method change for a tax year beginning before January 1, 2025, if the original return for that year is filed after August 28, 2025. The change uses a statement in lieu of Form 3115 and captures the cumulative effect through a Section 481(a) adjustment.⁹

Recovering Unamortized Amounts

Businesses that capitalized domestic R&E during 2022-2024 and do not qualify for the retroactive election can still accelerate what is left. Rev. Proc. 2025-28 provides a “recovery of unamortized amount” method that can be adopted for the first tax year beginning after December 31, 2024, using automatic accounting method change number 273.⁹ The method deducts the leftover capitalized balance rather than waiting for the original five-year schedule to run out.

Making the Accounting Method Change

Moving from the mandatory capitalization method used during 2022-2024 to Section 174A expensing is a change in accounting method under Section 446.⁶ Rev. Proc. 2025-28 consolidates the procedures and supersedes earlier guidance in Rev. Proc. 2024-23 and Rev. Proc. 2024-34 for most Section 174 purposes.

The process is lighter than a typical method change. Form 3115 is waived. Taxpayers file a statement in lieu of Form 3115 with their timely filed return, and the duplicate copy that normally must be mailed to the IRS National Office is also waived.⁹ The designated automatic change number is 273. The same streamlined procedure covers changing to Section 174A(a) immediate deduction, changing to Section 174A(c) 60-month amortization, making the small-business retroactive election, and adopting the recovery method for previously capitalized amounts.

Audit protection is limited. Under Rev. Proc. 2025-28, a taxpayer does not receive audit protection for expenditures paid or incurred in tax years beginning on or before December 31, 2021. A taxpayer that failed to change its method for 2022, the first year of mandatory capitalization, also does not receive audit protection for 2022 expenditures when it files the method change later.⁹ The IRS preserved its ability to challenge businesses that did not attempt to comply when the capitalization rules first took effect.

A Note on State Taxes

State conformity to the federal R&E rules varies. Some states automatically conform to the current Internal Revenue Code and follow Section 174A expensing without separate action. Others have fixed-date conformity tied to a prior version of the Code and may still require capitalization of domestic R&E at the state level. A handful of states decoupled from the TCJA capitalization requirement years ago and allowed state-level expensing throughout. Businesses operating in multiple states need to track R&E treatment separately for each state return.

1
Office of the Law Revision Counsel. 26 U.S. Code 174 – Amortization of Research and Experimental Expenditures
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eCFR. 26 CFR 1.174-2 – Definition 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
Office of the Law Revision Counsel. 26 U.S. Code 167 – Depreciation
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Office of the Law Revision Counsel. 26 U.S. Code 174A – Domestic Research or Experimental Expenditures
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Office of the Law Revision Counsel. 26 U.S. Code 446 – General Rule for Methods of Accounting
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Office of the Law Revision Counsel. 26 U.S. Code 197 – Amortization of Goodwill and Certain Other Intangibles
8
Internal Revenue Service. Notice 2024-12 – Clarifications and Modification to Initial Interim Guidance on Amortization of Specified Research or Experimental Expenditures under Section 174
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Internal Revenue Service. Rev. Proc. 2025-28