Do you buy or lease computer software for use in your
business? Do you develop computer software for use in your business, or for
sale or lease to others? Then you should be aware of the fun and complex rules
that apply to determine the tax treatment of the expenses of buying, leasing or
developing computer software.
Purchased software. Generally, the way to account for
the cost of purchased software is to amortize (ratably deduct) the cost over
the three-year period beginning with the month in which you placed the software
in service.
However, software that (1) is readily available for purchase
by the public, (2) is subject to a nonexclusive license and (3) hasn’t been
substantially modified (non-customized software), and (4) is placed in service
in tax years beginning before 2012 qualifies as “section 179 property,” and is
thus eligible for the Code Sec. 179 elective expensing
deduction that is generally available only for machinery and equipment. For tax
years beginning in 2010 or 2011, the deduction is limited to $500,000. The
limits are reduced by the cost of other section 179 property for which the
election is made. Also, the election is phased out for taxpayers placing more
than $2,000,000 of section 179 property into service during tax years beginning
in 2010 or 2011. Non-customized software acquired and placed in service after
Sept. 8, 2010 and before Jan. 1, 2012 is also eligible for a 100%-of-cost
depreciation deduction in the year that the software is placed in service
(bonus depreciation). The bonus depreciation is at a 50% rate if the software
is acquired or placed in service before Sept. 9, 2010. The bonus depreciation
for an item of software is reduced to take into account any portion of the
item’s cost for which a Code Sec. 179 election is made,
and regular depreciation deductions are reduced to take into account both the
bonus depreciation and any Code Sec. 179 election.
There are two other exceptions to the three-year
amortization rule. One exception requires that, if you buy the software as part
of a hardware purchase in which the price of the software isn’t separately
stated, you must treat the cost of the software as part of the cost of the hardware.
Thus, you must depreciate the software under the same method and over the same
period of years that you depreciate the hardware. The other exception requires
that if you buy the software as part of your purchase of all or a substantial
part of a business, the software must be amortized over 15 years (unless the
software is non-customized software).
Leased software. You must deduct the amounts you pay
to rent leased software in the tax year in which paid, if you are a cash-method
taxpayer, or the tax year for which the rentals are accrued, if you are an
accrual-method taxpayer. Generally, however, deductions aren’t permitted before
the years to which the rentals are allocable. Also, if a lease involves total
rentals of more than $250,000, special rules may apply.
Software you develop. Costs for developing computer
software (“writing the code yourself”) may be accounted for using any
of the following methods:
(1) amortizing the costs over a three-year period beginning
with the month that the software was placed in service;
(2) deducting the costs in the tax year in which the costs
are paid (if you are a cash-method taxpayer) or in the tax year in which the
costs are accrued (if you are an accrual-method taxpayer), but only if all of
your costs of developing the software are deducted this way;
(3) amortizing the costs over a five-year period beginning
with the completion of the development, but only if all of your costs of
developing software are amortized this way;
(4) amortizing the costs over a period longer than five
years, but only if the costs are Code Sec. 174 “research or experimental
expenditures.”
You should also be aware that if following any of the above
rules requires you to change your treatment of software costs, it will usually
be necessary for you to obtain IRS consent to the change by following
prescribed procedures.
Please give me a call if you have any questions.