21 May 2025 Tax reconciliation bill passed by Ways and Means would significantly affect cost recovery and accounting method provisions
The House Ways and Means Committee's budget reconciliation bill, as modified by the House Budget Committee (the Bill), would significantly affect cost recovery and other accounting method provisions. (See also, Tax Alerts 2025-1053 and 2025-1049 for an overview of the Bill's provisions and progress through the Ways & Means Committee, as well as Tax Alert 2025-1075 for discussion of the Bill's international tax provisions and Tax Alert 2025-1069 for discussion of proposed changes to energy credits enacted under the Inflation Reduction Act.) Under current law, taxpayers must treat research or experimental expenditures as chargeable to a capital account and amortized over five years (15 years for foreign research). Taxpayers also must treat all software development costs as research or experimental expenditures under IRC Section 174. Any capitalized research or experimental expenditures relating to property that is disposed of, retired, or abandoned during the amortization period must continue to be amortized throughout the remainder of the period. The Bill would suspend, under IRC Section 174, the required capitalization of domestic research or experimental expenditures for amounts paid or incurred in tax years beginning after December 31, 2024, and before January 1, 2030. Instead, the Bill would enact IRC Section 174A, a new, temporary section (applicable to amounts paid or incurred in tax years beginning before January 1, 2030), which would allow taxpayers to:
Like IRC Section 174, new IRC Section 174A would treat any amount paid or incurred for software development as a research or experimental expenditure. The Bill does not disturb the current law requirement under IRC Section 174 to capitalize and amortize foreign research or experimental expenditures over 15 years beginning with the midpoint of the tax year in which the expenditures are incurred. Taxpayers disposing of, retiring or abandoning property for which expenditures are paid or incurred could recover domestic capitalized research or experimental expenditures under IRC Section 174A. Taxpayers would still be precluded, under IRC Section 174(d), from recovering foreign capitalized research or experimental expenditures upon disposition, retirement or abandonment. Further, the Bill would amend IRC Section 174(d) to specifically disallow cost recovery via a reduction to the amount realized for property disposed, retired or abandoned. The Bill's amendment to IRC Section 174(d) would apply to property disposed, retired, or abandoned after May 12, 2025. For tax years beginning after December 31, 2024, and before January 1, 2030, the Bill would make a conforming amendment to IRC Section 280C(c), which would require taxpayers to reduce their domestic research or experimental expenditures taken into account under IRC Section 174A by the amount of the research credit under IRC Section 41. Alternatively, taxpayers could elect to claim a reduced IRC Section 41 research credit. The Bill would treat a change to deduct under IRC Section 174A domestic research or experimental expenditures paid or incurred in tax years beginning after December 31, 2024, as an automatic accounting method change made on a cutoff basis, meaning an IRC Section 481(a) catch-up adjustment would not be permitted or required. The Bill would also treat a change to capitalize and amortize under IRC Section 174 domestic research or experimental expenditures paid or incurred in tax years beginning after December 31, 2029, as an automatic accounting method change made on a cutoff basis. The Bill would make a conforming amendment to IRC Section 59(e) to exclude foreign research or experimental expenditures from the election to capitalize and recover research or experimental expenditures over 10 years. IRC Section 174 would be suspended, and IRC Section 174A would be effective, for amounts paid or incurred for domestic research in tax years beginning after December 31, 2024, and before January 1, 2030. The Bill would make the conforming amendments permanent, and the changes to IRC Section 280C(c) would apply to tax years beginning after December 31, 2024. The amendment to IRC Section 174(d) would apply to property disposed, retired, or abandoned after May 12, 2025. The Bill would authorize the Secretary to issue guidance for short tax years beginning after December 31, 2024, and ending before the date of enactment. The amendment temporarily suspending capitalization and amortization of domestic research or experimental expenditures, and excluding, under new IRC Section 174A, the restriction on the recovery of unamortized amounts in the event of disposal, retirement or abandonment of the related property, would be a welcome change that would significantly impact taxable income for taxpayers with substantial US research activities. The provision would restore the optionality of method of accounting for domestic research or experimental expenditures that existed before the TCJA's enactment. For taxpayers conducting research outside the United States, however, the provision would not provide any relief from capitalization or cost-recovery restrictions for foreign expenditures. The temporary nature of the benefit for domestic research and experimental expenditures could be a concern for US taxpayers as they plan and budget for future research. Current law allows taxpayers to claim additional depreciation (i.e., bonus depreciation) under IRC Section 168(k) in the year in which qualified property is placed in service through 2026 (with an additional year to place the property in service for qualified property with a longer production period, as well as certain aircraft). It also allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for certain qualified property with a longer production period, as well as certain aircraft). Bonus depreciation phases down to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027. Qualified property is defined as tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system (MACRS), certain off-the-shelf computer software, water utility property or certain qualified film and television productions, as well as certain qualified theatrical productions. Certain trees, vines, and fruit-bearing plants also are eligible for bonus depreciation when planted or grafted. Property is generally eligible for bonus depreciation if the taxpayer has not used the property previously (i.e., it is the taxpayer's first use of the property), provided the taxpayer does not acquire the "used" property from a related party or in a carryover basis transaction). The Bill would extend the additional first-year depreciation deduction through 2029 (2030 for longer production period property and certain aircraft). The Bill would allow taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025, and before January 1, 2030 (January 1, 2031, for certain qualified property with a longer production period, as well as certain aircraft). The Bill also would apply to certain plants planted or grafted after January 19, 2025, and before January 1, 2030. The Bill would also make permanent the rules under the percentage-of-completion method for allocating bonus depreciation to a long-term contract. The change would generally apply to property acquired and placed in service after January 19, 2025, as well as to specified plants planted or grafted after that date. Although not permanent, the extension of bonus depreciation through 2029 is generally a welcome inclusion in the Bill, particularly for taxpayers contemplating large bonus-eligible asset acquisitions in the next few years. Because the acquisition/placed-in-service date would be after January 19, 2025, taxpayers (even calendar-year taxpayers) may need to analyze whether assets would be eligible for 100% bonus depreciation, as assets acquired/placed in service in the first 19 days of 2025 would generally be eligible for only 40% bonus depreciation. Nonresidential real property is generally recovered over a 39-year period utilizing a straight-line depreciation (or recovery) method. Under current law, nonresidential real property is defined as buildings or structures that are not used for residential purposes, including office buildings, retail stores, warehouses and other commercial properties. Qualified improvement property (QIP) is any improvement made to an interior portion of a building that is nonresidential real property, if the taxpayer places the improvement in service after the date the taxpayer first places the building in service. QIP does not include improvements for which the expenditure is attributable to the enlargement of a building, an escalator or elevator, or the internal structural framework of the building. QIP also does not include improvements to residential real property. Taxpayers depreciate the QIP by using the straight-line method, half-year convention and a 15-year recovery period. IRC Section 1245 subjects depreciable personal property and certain depreciable real property disposed of at a gain to depreciation recapture. A taxpayer must recapture the gain on disposition of the property as ordinary income to the extent of earlier depreciation or amortization deductions that the taxpayer claimed for the property. The taxpayer must treat any remaining gain recognized on the sale of the IRC Section 1245 property as IRC Section 1231 gain. The Bill would establish an elective 100% depreciation allowance for qualified production property. It would define qualified production property as the portion of any nonresidential real property that meets the following requirements:
Qualified production property would not include any portion of the nonresidential real property used for offices, lodging, administrative services, sales activities, software engineering activities, parking or other functions unrelated to manufacturing, production or refining of tangible personal property. The Bill would define a qualified production activity as the manufacturing, production or refining of a qualified product. The Bill would define the term "production" as limited to agricultural and chemical production. The Bill would define a qualified product as any tangible personal property. For property acquired by the taxpayer after January 19, 2025, and before January 1, 2029, the Bill would treat the original-use requirement and beginning of construction requirement as satisfied if the property were not used in a qualified production activity from January 1, 2021, and the date of introduction. The determination of whether property was previously used in a qualified production activity would be made regardless of whether the taxpayer's activities result in a substantial transformation of the property. To determine whether property previously not used in qualifying activities is acquired after December 31, 2024, the Bill would treat the property as acquired not later than the date the taxpayer enters into a written binding contract for acquisition. To determine if property is acquired after January 1, 2030, the Bill would treat property as acquired not earlier than the date the taxpayer enters into a written binding contract to acquire the property. The Bill would establish special recapture rules if at any time during the 10-year period beginning on the date that any qualified production property is placed in service, the property:
If such a change in use occurs, the Bill would apply IRC Section 1245 as if the property had been disposed by the taxpayer the first time a change in use occurs for the property (thereby triggering an ordinary income inclusion). The inclusion would increase the taxpayer's basis in the property. Under the Bill, qualified production property would be treated as IRC Section 1245 property (rather than IRC Section 1250 property). The ability to apply 100% cost recovery to a portion of nonresidential real property used in the manufacturing process in the property's placed-in-service year would substantially benefit certain taxpayers. Regulations and/or other guidance would likely need to be released to provide a more substantial framework for claiming the deduction, tackling issues such how to allocate/bifurcate a building into the part that is integral to the production activity and the extent by which a taxpayer's activity constitutes "production," among other items. Businesses may elect to immediately expense up to $1 million of the cost of any IRC Section 179 property placed in service each tax year. If a business places in service more than $2.5 million of IRC Section 179 property in a tax year, the immediate expensing amount is reduced by the amount by which the IRC Section 179 property's cost exceeds $2.5 million. These amounts are indexed for inflation for tax years beginning after 2018. Thus, for tax years beginning in 2025, taxpayers may expense up to $1.25 million, and the phaseout threshold is $3.13 million. IRC Section 179 property includes tangible personal property or certain computer software that is purchased for use in the active conduct of a trade or business, as well as certain "qualified real property," which is defined as QIP and any of the following improvements to nonresidential real property placed in service after the date the property was first placed in service:
The Bill would increase the maximum amount a taxpayer may expense under IRC Section 179 from $1 million to $2.5 million, with the phaseout increasing to $4 million, for tax years beginning after 2024. The Bill would reduce the $2.5 million amount (but not below zero) by the amount by which the cost of the qualifying property placed in service during the tax year exceeds $4 million. Both expensing limitation amounts would be indexed for inflation for tax years beginning after 2025. The change would apply to property placed in service in tax years beginning after December 31, 2024. The increased dollar thresholds for expensing under IRC Section 179 would benefit certain taxpayers looking to deduct certain property in the year acquired and aligns with historic increases in thresholds that have been a part of prior legislative packages (e.g., the TCJA). Current law treats interest as an item of gross income, unless an exception applies. Those exceptions include interest on state and local bonds and interest received from the federal government for an action to recover property seized by the IRS. Current law also disallows a deduction for certain expenses and interest on indebtedness incurred to purchase or carry tax-exempt obligations. The Bill would allow banks insured under the Federal Deposit Insurance Act, domestic entities owned by a bank holding company, state or federally regulated insurance companies, domestic entities owned by a state law insurance holding company, and the Federal Agricultural Mortgage Corporation to exclude from gross income 25% of the interest income derived from qualified real estate loans. Qualified real estate loans would include loans that are made to a person other than a specified foreign entity after the date of enactment and before January 1, 2029, and are secured by:
The Bill would treat qualified real estate loans as tax-exempt obligations for purposes of disallowing interest deductions on indebtedness that qualified lenders incur to purchase or carry the loans. IRC Section 181 allows taxpayers to deduct up to $15 million of the aggregate production costs of any qualified film, television or live theatrical production that begins before January 1, 2026. The deduction increases to $20 million if the taxpayer incurs a significant portion of the production costs in areas eligible for designation (1) as a low-income community or (2) by the Delta Regional Authority as a distressed county or isolated area of distress. Additionally, qualified film, television and live theatrical productions placed in service after September 27, 2017, and before January 1, 2027, are considered qualified property eligible for bonus depreciation under IRC Section 168(k). A qualified production is considered placed in service by the taxpayer and, therefore, eligible for bonus depreciation, at the time of initial release, broadcast or live-staged performance. The Bill would expand IRC Section 181 to aggregate qualified-sound-recording-production costs of up to $150,000 per tax year. A qualified sound recording production would be defined as a sound recording produced and recorded in the United States. The IRC Section 181 deduction would only apply to qualified sound recordings that begin before January 1, 2026. The Bill would also expand the definition of qualified property eligible for bonus depreciation to include qualified sound recording productions placed in service before January 1, 2029. Expanding IRC Section 181 to permit the deduction of music production costs would help taxpayers who struggle with applying accelerated depreciation methods on a by-song recording basis. Because they would be IRC Section 181 property, taxpayers with song recordings with costs exceeding $150,000, after applying IRC Section 263A, would need to deduct bonus depreciation, unless they expressly opt out. This is the case even if they do not make an IRC Section 181 election for the sound recording, which would presumably be applied on a by-song basis. Current law requires businesses to maintain an inventories method if the production, purchase or sale of merchandise is a material income-producing factor to the business. Such businesses generally also must use an accrual method of accounting for tax purposes under the rules in IRC Section 446. Under an exception, certain small businesses with inventory that have average gross receipts of not more than $25 million do not have to use an accrual method of accounting. Instead, those businesses may (1) treat inventories as non-incidental materials and supplies; or (2) follow their financial accounting treatment of inventories. The Bill would increase the $25 million threshold of the gross receipts test to $80 million (indexed for inflation) for manufacturing taxpayers (other than tax shelters). The Bill would define "manufacturing taxpayer" as a "corporation or partnership if, during the three [tax] year period ending with the [tax] year preceding such [tax] year, substantially all of the gross receipts of the taxpayer are derived from the lease, rental, sale, license, exchange, or other disposition of 'qualified products.'"
The Bill would allow a manufacturing taxpayer to qualify for the cash method of accounting if the $80 million gross receipts test is met. That taxpayer also could qualify for exemptions from the limitation on business interest, uniform capitalization and accounting for inventories under IRC Section 471. The Bill would significantly expand the availability of the cash method of accounting by raising the gross receipts threshold from $25 million to $80 million (indexed for inflation) for qualifying manufacturers. These businesses could adopt the cash method of accounting and gain exemptions from the requirements to capitalize costs under IRC Sections 471 and 263A (UNICAP), as well as the limitation on business interest expenses. The Bill could present a strategic opportunity for eligible businesses to simplify their tax compliance. The adjusted basis of an amortizable IRC Section 197 intangible held in connection with a trade or business is amortized on a straight-line basis over 15 years. The Bill would limit the ability of a sports franchise business (e.g., football, basketball or hockey) to amortize the adjusted basis of an amortizable IRC Section 197 asset by excluding 50% of the asset's adjusted basis from amortization. Decreasing the ability of sports franchises to amortize IRC Section 197 intangibles would impact the value of these franchises and put more pressure on the allocation of purchase price to amortizable and depreciable assets. This provision would not apply to franchises acquired before the enactment date.
Document ID: 2025-1110 | ||||||
