Section 174 Expensing After OBBBA: What Changed for R&D Costs

Three filing seasons of capitalizing research costs ended with a single section of the One Big Beautiful Bill Act. Section 174 expensing is back for domestic research, and the mechanism is not a repeal of the capitalization rule. Congress left old Section 174 standing and wrote a new section next to it.

What Changed for Section 174 Expensing Under OBBBA?

OBBBA Section 70302 added a new IRC Section 174A, titled "Domestic research or experimental expenditures," providing that notwithstanding Section 263, "there shall be allowed as a deduction any domestic research or experimental expenditures" paid or incurred during the taxable year. The amendments apply to amounts paid or incurred in taxable years beginning after December 31, 2024.

Read that as an addition, not a repeal. Section 174 was not struck from the Code. OBBBA Section 70302(b)(1) rewrote it so that it now reaches only foreign research, and inserted 174A ahead of it for everything else. This is not a return to pre-2022 law, where one Section 174 covered every research dollar. It is a split system, and the geography of the work decides which half a cost falls into.

Capitalization is still on the table for domestic costs, but now only by election. Section 174A(c) lets a taxpayer charge domestic research to a capital account and take an amortization deduction "ratably over a period of not less than 60 months, beginning with the month in which the taxpayer first realizes benefits from such expenditures." That is not the midpoint convention your staff have been running since 2022. The clock starts when benefits are first realized, which for a project still in development can be a later year entirely. Under Section 174A(c)(2), the election has to be made no later than the time prescribed for filing the return including extensions, and once made it binds for that year and subsequent years unless the Secretary approves a change.

Which Costs Count as Domestic Research?

Domestic research is every research or experimental expenditure paid or incurred in the taxpayer's trade or business except the portion attributable to research conducted outside the United States, Puerto Rico, and the U.S. possessions. Section 174A(b) says so by carve-out rather than by definition, reaching such expenditures "other than such expenditures which are attributable to foreign research (within the meaning of Section 41(d)(4)(F))."

That carve-out is where the errors live, because it turns on geography rather than on who paid or which entity booked the cost. Notice 2023-63 states the boundary directly: "The term foreign research means any research conducted outside the United States, the Commonwealth of Puerto Rico, or any U.S. territory or other possession of the United States."

Read that list twice, because it is a list of places where research is not foreign. Research conducted in Puerto Rico is not foreign research for this purpose, and neither is research in Guam, the U.S. Virgin Islands, or any other U.S. possession. A San Juan engineering team is domestic research, currently deductible under 174A. What lands on the 15-year schedule is the portion of development work performed abroad.

Character is the second test. Treas. Reg. 1.174-2 defines research or experimental expenditures as "expenditures incurred in connection with the taxpayer's trade or business which represent research and development costs in the experimental or laboratory sense." The test is uncertainty, which exists if the available information does not establish the capability or method for developing the product, or its appropriate design. The same regulation excludes quality-control testing, efficiency surveys, management studies, consumer surveys, advertising, the acquisition of another's patent, model, production or process, and research connected with literary or historical projects.

One point from that regulation belongs in the workpaper. Production costs paid or incurred after uncertainty is eliminated are not eligible, subject to the component rule in paragraph (a)(5).

Software is the one bright line in the statute itself. Section 174A(d)(3) treats any amount paid or incurred in connection with the development of any software as a research or experimental expenditure. Section 174A(d)(1) and (d)(2) push the other way, excluding land, property subject to depreciation or depletion, and mineral or oil and gas exploration costs.

Treas. Reg. 1.174-2 was last amended by T.D. 9680, 79 FR 42195, on July 21, 2014, so it predates both TCJA and OBBBA. Rev. Proc. 2025-28 is explicit that no inference should be drawn from its method-change rules about issues under Notice 2023-63 for the TCJA years. The character definition holds; the recovery mechanics around it moved twice.

What Happens to the Foreign Amortization Tail?

Nothing changed for foreign research, which still amortizes ratably over 15 years from the midpoint of the taxable year, or $3,333 in year one on $100,000 of spend. Rev. Proc. 2025-28 confirms that after the amendment, Section 174 applies only to foreign research and that "such expenditures continue to be amortized ratably over a 15-year period beginning with the midpoint of the taxable year in which such expenditures are paid or incurred."

Full recovery takes 16 taxable years, not 15, because the 180-month period starts at the July 1 midpoint of the first year and does not close until June 30 of the sixteenth.

The 15-year foreign period is unchanged by OBBBA. Clients with both kinds of spend keep two schedules indefinitely, and foreign balances already on the books from 2022 through 2024 keep running out on that 15-year period. Nothing in Section 70302 accelerates them.

One foreign-side change is easy to miss. OBBBA amended Section 174(d) to insert "or reduction to amount realized" after "no deduction," effective for property disposed, retired, or abandoned after May 12, 2025. The statute adds that no inference should be drawn about how Section 174(d) applied for taxable years beginning before May 13, 2025.

Making the Method Change

Rev. Proc. 2025-28 makes the change to comply with Section 174A an automatic change under its section 7.02, designated automatic accounting method change number 273. For that change, "a statement in lieu of a Form 3115 is authorized," the duplicate-copy requirement under Rev. Proc. 2015-13 is waived, and the change is made on a cut-off basis for the first taxable year beginning after December 31, 2024, with no Section 481(a) adjustment. The exception is a taxable year that began after December 31, 2024 and ended before the July 4, 2025 enactment date, necessarily a short year, which runs on a modified cut-off basis and does take a Section 481(a) adjustment.

Two other change numbers sit next to it. DCN 265 covers domestic research paid or incurred in taxable years beginning after December 31, 2021 and before January 1, 2025 under the old rules. DCN 274 covers foreign research.

If the client already filed on or before September 15, 2025 for a taxable year beginning after December 31, 2024, and either deducted the domestic costs or reported them on Part VI of Form 4562 and amortized them correctly under 174A(c), section 7.02(6) deems the taxpayer to have complied. Audit protection is limited either way: section 7.02(8) provides none for expenditures paid or incurred in taxable years beginning before January 1, 2025.

The unamortized balance from 2022 through 2024 is where the money is. OBBBA Section 70302(f)(2) lets a taxpayer elect to deduct the remaining unamortized amount of previously capitalized domestic research either in full in the first taxable year beginning after December 31, 2024, or ratably over the 2-taxable-year period beginning with that year.

Take a calendar-year client that spent $100,000 of domestic research in each of 2022, 2023, and 2024 and capitalized all of it on the 5-year midpoint convention. By December 31, 2024 the 2022 layer had run 30 of 60 months, the 2023 layer 18, and the 2024 layer 6, leaving $50,000, $70,000, and $90,000. Of $300,000 spent, $210,000 is still in the capital account on January 1, 2025. The client either takes the whole $210,000 on the 2025 return or splits it evenly, $105,000 in 2025 and $105,000 in 2026. That split is a division by two of the remaining balance, not a ratio to income.

One door has already closed. The small business retroactive election expired on July 6, 2026. Section 70302(f)(1) let an eligible small business apply the new rules from taxable years beginning after December 31, 2021 rather than 2024, by amending every affected return, subject to the Section 448(c) gross receipts test. The July 4, 2026 statutory deadline fell on a Saturday, so Section 7503 pushed it to Monday, July 6, 2026, the same date that governed late and revoked Section 280C(c)(2) elections.

Bottom Line

Domestic research is deducted by default, and capitalizing it is an election you make by the extended due date. Foreign research keeps amortizing over 15 years, and OBBBA left that period alone. The unamortized 2022 through 2024 domestic balance comes back either all in 2025 or half in 2025 and half in 2026, on a statement rather than a Form 3115.

The item I would re-check on every engagement is geography, because the instinct runs backwards. Work done in San Juan reads as offshore and is not foreign research. Treat it as foreign and you capitalize costs the client could have deducted in full.

For the other OBBBA cost-recovery provision on these same returns, see bonus depreciation changes under OBBBA. For the pass-through side, the QBI deduction walkthrough covers Section 199A.

I built Tax Orator partly because tracing a chain like this, from enacted statute to revenue procedure to a regulation last amended in 2014, used to cost me a Saturday.