Stay Current: Explore the Latest on 2025 Tax Reform and R&E Deductions
Discover how the 2025 tax reform (P.L. 119-21) restores immediate deductions for domestic research and experimental (R&E) expenses, reversing the TCJA’s capitalization rule. Learn about the new IRC Section 174A and what this change means for businesses investing in innovation.
In 2017, the Tax Cuts and Jobs Act (TCJA) changed how businesses write off research and development (R&D) tax credits. Starting in 2022, companies had to amortize domestic research costs over five years — or 15 years for foreign research — rather than being able to write off 100% of the costs.
Earlier this year, the 2025 tax reform, P.L. 119-21, permanently reinstated the pre-TCJA rules for domestic R&D, once again allowing for immediate deduction of research expenditures. While capitalization is no longer required, companies may still see a benefit in choosing a capitalization strategy over fully expensing R&D costs.
What Is R&D Capitalization?
R&D capitalization refers to the process of recording certain research costs as an asset rather than as an expense on a company’s profit and loss statement. Only specific types of R&D costs meet the Generally Accepted Accounting Principles (GAAP) criteria for capitalization. Capitalizable costs may include prototype development, labor costs for employees involved in R&D and contract research expenses.
The Impact of R&D Capitalization
Utilizing capitalization and amortization for R&D costs can impact cash flow for companies, as well as the speed at which start-ups may generate net operating losses. Additional impacts of capitalization include:
- International Tax Impact: R&D costs amortization may affect GILTI, FDII and Foreign Tax Credits.
- State and Local Impact: R&D costs amortization will likely increase federal taxable income, which may increase state and local tax.
- Interest Deduction Limitations: R&D amortization may impact the computation of the interest deduction limitation under IRC Section 163(j).
Businesses may also see improved financial metrics when utilizing capitalization, since recording R&D expenses as assets can reduce operating expenses.
How R&D Capitalization Rules Work
SRE expenditures generally include all costs incurred in the experimental or laboratory sense incident to developing or improving a product, including software (See IRC Section 174(c)(3) and Treas. Reg. Section 1.172-2(a)(1)). These include:
- Labor costs
- Materials and supplies cross
- Depreciation or amortization for property used in SRE activities
- Patent costs
- Travel costs related to SRE activities
- Some amount of operation and management costs (i.e., overhead)
Since 2022, research and development (R&D) capitalization has caused the taxable income of many U.S. taxpayers to increase. This is expected to improve with the enactment of P.L. 119-21.
2025 Updates: Domestic R&D Capitalization Suspended
Signed into law on July 4, 2025, P.L. 119-21 suspended required capitalization under Internal Revenue Code (IRC) Section 174. The tax reform introduced the new IRC Section 174A, allowing taxpayers to choose one of the three options related to specified research and experimental expenditures (SREs):
- Deduct their current year domestic SREs
- Elect to capitalize domestic SREs over a minimum period of 60 months or the useful life of the research
- Elect to capitalize domestic SREs for a ten-year period, beginning with the year in which the expenditure incurred (See IRC Section 59(e))
Transition Changes for SREs
For purposes of IRC Section 41, IRC Section 280C would again apply (for tax years beginning after December 31, 2024, and before January 1, 2030). Accordingly, such taxpayers are required to reduce their SREs by the amount of gross R&D credit or elect a reduced research credit on a timely filed tax return.
While taxpayers can fully expense domestic capitalized SREs upon the disposition of the trade or business to which they relate, that favorable treatment does not exist for foreign capitalized SREs. Transition rules require taxpayers to adopt changes to the treatment of domestic SREs for tax years beginning after December 31, 2024, and for tax years beginning after December 31, 2029, as automatic accounting method changes on a cutoff basis.
Next Steps
While these new provisions should provide relief for taxpayers who were negatively impacted by TCJA’s mandatory capitalization regime, they are not retroactive and are temporary. As such, prior-year SRE expenditures will still be governed by prior-year-calculated amortization schedules. The ability to recover domestic SREs upon the disposition of a trade or business, however, provides businesses with additional flexibility.
Regardless of whether the proposed changes become law, taxpayers will still be subject to enhanced documentation requirements for the 2025 tax year. Accordingly, meeting with a tax professional would be recommended (see IRS Updates Form 6765 for 2025 R&D Tax Credits).
Your Guide Forward
Cherry Bekaert's R&D Tax Credits team is ready to help you navigate these updates. Our tax advisors can help maintain compliance with the new standards and optimize your research credit claims. Reach out to Cherry Bekaert today to speak with a trusted advisor who can guide you through these changes, allowing you to focus on innovation and growth.
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