Tax Guidance on Treating Research Expenses as Deferred under Section 174(b) | Lecture notes Accounting

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26 CFR Ch. I (4–1–10 Edition) § 1.174–4

(iv) Indicate the number of months

(not less than 60) selected for amortiza-

tion of the expenditures, if any, which

are to be treated as deferred expenses

under section 174(b);

(v) State that, upon approval of the

application, the taxpayer will make an

accounting segregation on his books

and records of the research or experi-

mental expenditures to which the

change in method is to apply; and

(vi) State the reasons for the change.

If permission is granted to make the

change, the taxpayer shall attach a

copy of the letter granting permission

to his income tax return for the first

taxable year in which the different

method is effective.

(4) Special rules. If the last day pre-

scribed by law for filing a return for

any taxable year (including extensions

thereof) to which section 174(a) is ap-

plicable falls before January 2, 1958,

consent is hereby given for the tax-

payer to adopt the expense method or

to change from the expense method to

a different method. In the case of a

change from the expense method to a

different method, the taxpayer, on or

before January 2, 1958, must submit to

the district director for the internal

revenue district in which the return

was filed the information required by

subparagraph (3) of this paragraph. For

any taxable year for which the expense

method or a different method is adopt-

ed pursuant to this subparagraph, an

amended return reflecting such method

shall be filed on or before January 2,

1958, if such return is necessary.

§ 1.174–4 Treatment as deferred ex-

penses.

(a) In general. (1) If a taxpayer has

not adopted the method provided in

section 174(a) of treating research or

experimental expenditures paid or in-

curred by him in connection with his

trade or business as currently deduct-

ible expenses, he may, for any taxable

year beginning after December 31, 1953,

elect to treat such expenditures as de-

ferred expenses under section 174(b),

subject to the limitations of subpara-

graph (2) of this paragraph. If a tax-

payer has adopted the method of treat-

ing such expenditures as expenses

under section 174(a), he may not elect

to defer and amortize any such expend-

itures unless permission to do so is

granted under section 174(a)(3). See

paragraph (b) of this section.

(2) The election to treat research or

experimental expenditures as deferred

expenses under section 174(b) applies

only to those expenditures which are

chargeable to capital account but

which are not chargeable to property of

a character subject to an allowance for

depreciation or depletion under section

167 or 611, respectively. Thus, the elec-

tion under section 174(b) applies only if

the property resulting from the re-

search or experimental expenditures

has no determinable useful life. If the

property resulting from the expendi-

tures has a determinable useful life,

section 174(b) is not applicable, and the

capitalized expenditures must be amor-

tized or depreciated over the deter-

minable useful life. Amounts treated as

deferred expenses are properly charge-

able to capital account for purposes of

section 1016(a)(1), relating to adjust-

ments to basis of property. See section

1016(a)(14). See section 174(c) and para-

graph (b)(1) of § 1.174–2 for treatment of

expenditures for the acquisition or im-

provement of land or of depreciable or

depletable property to be used in con-

nection with the research or experi-

mentation.

(3) Expenditures which are treated as

deferred expenses under section 174(b)

are allowable as a deduction ratably

over a period of not less than 60 con-

secutive months beginning with the

month in which the taxpayer first real-

izes benefits from the expenditures.

The length of the period shall be se-

lected by the taxpayer at the time he

makes the election to defer the expend-

itures. If a taxpayer has two or more

separate projects, he may select a dif-

ferent amortization period for each

project. In the absence of a showing to

the contrary, the taxpayer will be

deemed to have begun to realize bene-

fits from the deferred expenditures in

the month in which the taxpayer first

puts the process, formula, invention, or

similar property to which the expendi-

tures relate to an income-producing

use. See section 1016(a)(14) for adjust-

ments to basis of property for amounts

allowed as deductions under section

174(b) and this section. See section 165

and the regulations thereunder for

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§ 1.174–4 26 CFR Ch. I (4–1–10 Edition)

(iv) Indicate the number of months (not less than 60) selected for amortiza- tion of the expenditures, if any, which are to be treated as deferred expenses under section 174(b); (v) State that, upon approval of the application, the taxpayer will make an accounting segregation on his books and records of the research or experi- mental expenditures to which the change in method is to apply; and (vi) State the reasons for the change.

If permission is granted to make the change, the taxpayer shall attach a copy of the letter granting permission to his income tax return for the first taxable year in which the different method is effective. (4) Special rules. If the last day pre- scribed by law for filing a return for any taxable year (including extensions thereof) to which section 174(a) is ap- plicable falls before January 2, 1958, consent is hereby given for the tax- payer to adopt the expense method or to change from the expense method to a different method. In the case of a change from the expense method to a different method, the taxpayer, on or before January 2, 1958, must submit to the district director for the internal revenue district in which the return was filed the information required by subparagraph (3) of this paragraph. For any taxable year for which the expense method or a different method is adopt- ed pursuant to this subparagraph, an amended return reflecting such method shall be filed on or before January 2, 1958, if such return is necessary.

§ 1.174–4 Treatment as deferred ex- penses. (a) In general. (1) If a taxpayer has not adopted the method provided in section 174(a) of treating research or experimental expenditures paid or in- curred by him in connection with his trade or business as currently deduct- ible expenses, he may, for any taxable year beginning after December 31, 1953, elect to treat such expenditures as de- ferred expenses under section 174(b), subject to the limitations of subpara- graph (2) of this paragraph. If a tax- payer has adopted the method of treat- ing such expenditures as expenses under section 174(a), he may not elect to defer and amortize any such expend-

itures unless permission to do so is granted under section 174(a)(3). See paragraph (b) of this section. (2) The election to treat research or experimental expenditures as deferred expenses under section 174(b) applies only to those expenditures which are chargeable to capital account but which are not chargeable to property of a character subject to an allowance for depreciation or depletion under section 167 or 611, respectively. Thus, the elec- tion under section 174(b) applies only if the property resulting from the re- search or experimental expenditures has no determinable useful life. If the property resulting from the expendi- tures has a determinable useful life, section 174(b) is not applicable, and the capitalized expenditures must be amor- tized or depreciated over the deter- minable useful life. Amounts treated as deferred expenses are properly charge- able to capital account for purposes of section 1016(a)(1), relating to adjust- ments to basis of property. See section 1016(a)(14). See section 174(c) and para- graph (b)(1) of § 1.174–2 for treatment of expenditures for the acquisition or im- provement of land or of depreciable or depletable property to be used in con- nection with the research or experi- mentation. (3) Expenditures which are treated as deferred expenses under section 174(b) are allowable as a deduction ratably over a period of not less than 60 con- secutive months beginning with the month in which the taxpayer first real- izes benefits from the expenditures. The length of the period shall be se- lected by the taxpayer at the time he makes the election to defer the expend- itures. If a taxpayer has two or more separate projects, he may select a dif- ferent amortization period for each project. In the absence of a showing to the contrary, the taxpayer will be deemed to have begun to realize bene- fits from the deferred expenditures in the month in which the taxpayer first puts the process, formula, invention, or similar property to which the expendi- tures relate to an income-producing use. See section 1016(a)(14) for adjust- ments to basis of property for amounts allowed as deductions under section 174(b) and this section. See section 165 and the regulations thereunder for

Internal Revenue Service, Treasury § 1.174–

rules relating to the treatment of losses resulting from abandonment. (4) If expenditures which the tax- payer has elected to defer and deduct ratably over a period of time in accord- ance with section 174(b) result in the development of depreciable property, deductions for the unrecovered expend- itures, beginning with the time the asset becomes depreciable in character, shall be determined under section 167 (relating to depreciation) and the regu- lations thereunder. For example, for the taxable year 1954, A, who reports his income on the basis of a calendar year, elects to defer and deduct ratably over a period of 60 months research and experimental expenditures made in connection with a particular project. In 1956, the total of the deferred ex- penditures amounts to $60,000. At that time, A has developed a process which he seeks to patent. On July 1, 1956, A first realized benefits from the mar- keting of products resulting from this process. Therefore, the expenditures deferred are deductible ratably over the 60-month period beginning with July 1, 1956 (when A first realized bene- fits from the project). In his return for the year 1956. A deducted $6,000; in 1957, A deducted $12,000 ($1,000 per month). On July 1, 1958, a patent protecting his process is obtained by A. In his return for 1958, A is entitled to a deduction of $6,000, representing the amortizable portion of the deferred expenses attrib- utable to the period prior to July 1,

The balance of the unrecovered expenditures ($60,000 minus $24,000, or $36,000) is to be recovered as a deprecia- tion deduction over the life of the pat- ent commencing with July 1, 1958. Thus, one-half of the annual deprecia- tion deduction based upon the useful life of the patent is also deductible for 1958 (from July 1 to December 31). (5) The election shall be applicable to all research and experimental expendi- tures paid or incurred by the taxpayer or, if so limited by the taxpayer’s elec- tion, to all such expenditures with re- spect to the particular project, subject to the limitations of subparagraph (2) of this paragraph. The election shall apply for the taxable year for which the election is made and for all subse- quent taxable years, unless a change to a different treatment is authorized by

the Commissioner under section 174(b)(2). See paragraph (b)(2) of this section. Likewise, the taxpayer shall adhere to the amortization period se- lected at the time of the election un- less a different period of amortization with respect to a part or all of the ex- penditures is similarly authorized. However, no change in method will be permitted with respect to expenditures paid or incurred before the taxable year to which the change is to apply. In no event will the taxpayer be per- mitted to treat part of the expendi- tures with respect to a particular project as deferred expenses under sec- tion 174(b) and to adopt a different method of treating the balance of the expenditures relating to the same project for the same taxable year. The election under this section shall not apply to any expenditures paid or in- curred before the taxable year for which the taxpayer makes the election. (b) Election and change of method —(1) Election. The election under section 174(b) shall be made not later than the time (including extensions) prescribed by law for filing the return for the tax- able year for which the method is to be adopted. The election shall be made by attaching a statement to the tax- payer’s return for the first taxable year to which the election is applicable. The statement shall be signed by the tax- payer (or his duly authorized rep- resentative), and shall: (i) Set forth the name and address of the taxpayer; (ii) Designate the first taxable year to which the election is to apply; (iii) State whether the election is in- tended to apply to all expenditures within the permissible scope of the election, or only to a particular project or projects, and, if the latter, include such information as will identify the project or projects as to which the elec- tion is to apply; (iv) Set forth the amount of all re- search or experimental expenditures paid or incurred during the taxable year for which the election is made; (v) Indicate the number of months (not less than 60) selected for amortiza- tion of the deferred expenses for each project; and (vi) State that the taxpayer will make an accounting segregation in his

Tax Guidance on Treating Research Expenses as Deferred under Section 174(b), Lecture notes of Accounting

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§ 1.174–4 26 CFR Ch. I (4–1–10 Edition)

Internal Revenue Service, Treasury § 1.174–