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 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 2014 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 that begin
in 2012 or 2013, the deduction is limited to $500,000. The limit is 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 2012 or 2013.
Non-customized software that is acquired and placed in service before Jan. 1,
2014 is also eligible for a 50%-of-cost depreciation deduction in the year that
the software was placed in service (bonus depreciation). 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 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 us a call if you have any questions. We would be
pleased to assist you in applying the tax rules for treating computer software
costs in the way that is most advantageous for you.
(651) 621-5777, (952) 583-9108, (612) 224-2476, (763)
269-5396
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