What is R&D capitalization?

As the saying goes, the only constants in life are death and taxes. We’d venture to add that another one of life’s constants are that taxes—and the laws that govern them—are always changing. 

This is evident in recent changes to the way companies handle their research and development (R&D) costs. Rather than immediately writing off R&D costs, companies are now required to adopt a practice called R&D capitalization to view these costs as an asset instead of an expense. 

Below, we talk through why R&D capitalization is required, how it works, and what you can do to help mitigate the effects.   

Key takeaways:

• The 2017 Tax Cuts and Jobs Act (TCJA) resulted in changes to the treatment of research or experimental (R&E) expenditures under Section 174.
• For tax years beginning after December 31, 2021, companies are required to capitalize and amortize their R&D costs. 
• These costs must be amortized over a period of five years if incurred within the U.S., and 15 years if incurred outside the U.S.

Table of contents:

1. What is R&D capitalization?
2. How does R&D capitalization work?
3. How to mitigate the effects of R&D capitalization
4. How to benefit from the R&D tax credit
5. What R&D costs can be capitalized?
6. How Pluralsight Flow can help you streamline R&D cost reporting

What is R&D capitalization?

Why is this relevant? Prior to 2022, companies could deduct full R&D costs—also known as research and expenditure (R&E) costs in the tax code—on their tax return. The 2017 Tax Cuts and Jobs Act put a stop to this practice. 

As of January 1, 2022, companies are required to capitalize and amortize the cost of research and development—including software development cost. 

So rather than immediately deducting R&D costs in the same fiscal year, you have to spread those costs out across five or 15 years—five years for R&D expenditures incurred within the U.S. and 15 years for R&D expenditures incurred abroad. 

It’s worth noting that there’s no change to the generally accepted accounting principles (GAAP). R&D will continue to be expensed in companies’ financial reporting statements.