11 July 2025 Tax reconciliation legislation significantly affects cost recovery and accounting method provisions
H.R. 1 (known as the "One Big Beautiful Bill" or the Act herein) signed into law on July 4, 2025, significantly affects cost recovery and other accounting method provisions. The Act also enhances the IRC Section 48D advanced manufacturing investment credit. (Certain notable international provisions are addressed in a forthcoming Tax Alert.) Under current law, taxpayers must treat research or experimental expenditures, including software development costs, as chargeable to capital account and amortize those expenditures over five years (15 years for foreign research). 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.
or
The Act 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. The Act amends IRC Section 174(d) to require continued amortization of foreign research or experimental expenditures for property that is disposed of after May 12, 2025, even if the expenditures would otherwise reduce the amount realized from the disposition. The Act makes 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. However, domestic research or experimental expenditures that are otherwise deductible under IRC Section 174A are eligible for the election under IRC Section 59(e). Lastly, the Act makes various conforming amendments to other provisions of the IRC, including a conforming amendment to IRC Section 280C(c) to provide that domestic research or experimental expenditures otherwise taken into account under Chapter 1 of the IRC (whether deducted or capitalized) are reduced by the amount of the credit allowed under IRC Section 41(a). The new law is generally effective for amounts paid or incurred for domestic research in tax years beginning after December 31, 2024. Small businesses that meet the gross receipts test under IRC section 448(c) (generally average gross receipts of $31 million or less), however, can elect to apply the new law retroactively to tax years beginning after December 31, 2021, by filing amended returns. A change to apply the new law is generally treated as a change in method of accounting under IRC Section 446. Additionally, the Act allows all taxpayers that incurred and capitalized (under IRC Section 174) domestic research or experimental expenditures after December 31, 2021, and before January 1, 2025, to elect to deduct any remaining unamortized amount with respect to such expenditures in their first tax year beginning after December 31, 2024, or ratably over the two tax year period beginning with the first tax year that begins after December 31, 2024. The election is treated as a change in method of accounting for amortization that is implemented on a cut-off basis (no IRC Section 481(a) adjustment), suggesting that the accelerated deduction retains its character as an amortization deduction. The Act makes new IRC Section 174A permanent for tax years beginning after December 31, 2024, which provides welcome certainty for taxpayers. Likewise, small businesses will undoubtedly welcome the option to elect to retroactively deduct domestic research or experimental expenditures. The election to accelerate unamortized domestic research or experimental expenditures that were capitalized under the Tax Cuts and Jobs Act (TCJA) generally benefits all taxpayers by allowing recovery of capitalized amounts in the 2025 tax year (or 2025 and 2026 tax years, at the election of the taxpayer). However, taxpayers should carefully model out the election options under the new law, including the acceleration election, due to the impact these elections can have on other provisions of the IRC, including the corporate alternative minimum tax under IRC Section 55. To implement new IRC Section 174A and/or make any of the elections described above, certain procedural requirements must be satisfied. The Act instructs the Secretary of the Treasury to publish guidance to establish certain of these procedural requirements, namely those necessary for taxpayers to avail themselves of the elections described above. Once guidance is published, it will be clearer how taxpayers can properly implement new IRC Section 174A and effectuate these elections. Unlike current IRC Section 174 provisions, IRC Section 174A does not restrict the recovery of unamortized domestic research or experimental expenditures (to the extent capitalized) in the event of disposal, retirement or abandonment of the related property. This change significantly impacts taxable income for taxpayers with substantial US research activities that dispose of research property or that abandon unsuccessful research efforts. Further, IRC Section 174A provides flexibility in cost recovery for domestic research or experimental expenditures similar to the provisions that existed before the TCJA's enactment. For taxpayers conducting research outside the United States, however, the provision does not provide any relief from required capitalization and amortization of foreign expenditures. IRC Section 163(j) limits the business interest expense that may be deducted in a tax year to the sum of (i) the taxpayer's business interest income, as defined in IRC Section 163(j)(6), (ii) 30% of the taxpayer's adjusted taxable income (ATI), as defined in IRC Section 163(j)(8), and (iii) the taxpayer's floor plan financing interest, as defined in IRC Section 163(j)(9). For tax years beginning before January 1, 2022, a taxpayer's ATI was based on earnings before interest, taxes, depreciation and amortization (EBITDA). Thereafter, a taxpayer's ATI includes any deduction allowable for depreciation, depletion, or amortization (i.e., the IRC Section 163(j) limitation is generally based on earnings before interest and taxes (EBIT)). While IRC Section 163(j)(8) does not address a US shareholder's treatment of CFC income inclusions under IRC Sections 78, 951(a) or 951A(a), the final IRC Section 163(j) regulations do not include such amounts (referred to as "specified deemed inclusions") in the determination of the US shareholder's ATI. However, under proposed IRC Section 163(j) regulations, which taxpayers may have been applying prior to finalization, a US shareholder may be able to effectively include in ATI a portion of the specified deemed inclusions to the extent there is CFC excess taxable income as defined in the proposed regulations. Under the final IRC Section 163(j) regulations, IRC Section 163(j) generally applies after provisions that subject business interest expense to disallowance, deferral, capitalization or other limitation. As a result, capitalized interest expense is not treated as business interest expense for purposes of IRC Section 163(j). The Act amends IRC Section 163(j)(8)(A)(v) to once again compute ATI without regard to any deduction allowable for depreciation, amortization, or depletion (i.e., based on EBITDA). The Act makes this change permanent. The Act also amends IRC Section 163(j)(8)(A) to adjust the ATI calculation of a US shareholder by fully excluding CFC income inclusions under IRC Sections 78, 951(a) and 951A. Additionally, the Act excludes from ATI the corresponding deductions allowed under IRC Sections 245A(a) (by reason of IRC Section 964(e)(4)) and 250(a)(1)(B) by reason of such CFC income inclusions. The Act establishes a new IRC Section 163(j) ordering rule to coordinate between the IRC Section 163(j) limitation and interest capitalization provisions. Specifically, the Act provides that the IRC Section 163(j) limitation applies before all interest capitalization provisions other than the mandatory interest capitalization provisions in IRC Sections 263(g) and 263A(f). As a result, business interest expense capitalized under elective capitalization provisions is subject to the IRC Section 163(j) limitation. The Act provides special ordering rules for determining the extent to which allowed interest (i.e., interest allowed after the application of the IRC Section 163(j) limitation) comes from the taxpayer's pool of electively capitalized interest vs. deductible interest and provides that allowed interest first comes from the taxpayer's pool of electively capitalized interest. The provisions on CFC income inclusions and interest capitalization coordination are effective for tax years beginning after December 31, 2025. Making permanent the addback of depreciation, amortization and depletion to ATI (in conjunction with the return of 100% bonus depreciation) provides significant relief to certain taxpayers by reducing the amount of interest limited under IRC Section 163(j). However, certain taxpayers with foreign operations may see this benefit eroded (starting in tax years beginning after December 31, 2025) by the exclusion of subpart F and GILTI (and any associated IRC Section 78 gross up or IRC Sections 245A(a) and 250(a)(1)(B) deductions) from ATI. Due to the IRC Section 163(j) ordering rule, taxpayers that remain IRC Section 163(j) limited (even after the reversion to EBITDA) in tax years beginning after 2025 will not be able to reduce the impact of the IRC Section 163(j) limitation through elective interest capitalization. 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, 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 Act permanently extends bonus depreciation and allows taxpayers to claim 100% bonus depreciation for qualified property acquired after January 19, 2025, as well as specified plants planted or grafted on or after that date. In addition, the Act modifies IRC Section 168(k)(10) to give taxpayers the option to elect to claim 40% bonus depreciation (or 60% for longer production period property or certain aircraft) in lieu of 100% bonus depreciation for qualified property placed in service during the first tax year ending after January 19, 2025 (Transitional Election). The new law (other than the Transition Election) applies to property acquired and placed in service after January 19, 2025, as well as to specified plants planted or grafted after that date. Property will not be treated as acquired after the date on which a written binding contract is entered into for such acquisition. Permanent 100% bonus depreciation is a welcome development, particularly for taxpayers contemplating large bonus-eligible asset acquisitions at the time of enactment. Because the acquisition of otherwise eligible property must occur after January 19, 2025, to qualify for 100% bonus depreciation, taxpayers will need to analyze whether assets placed in service after January 19, 2025, satisfy the acquisition date requirements, which will generally involve a review of the underlying purchase contracts. Property acquired on or before January 19, 2025, is subject to the bonus depreciation rules under current law. Taxpayers that do not want to immediately return to 100% expensing are afforded the option to elect a reduced bonus depreciation percentage (40% for most property) in the first tax year ending after January 19, 2025. 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. 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 Act establishes an elective 100% depreciation allowance for qualified production property. The term qualified production property means that portion of any nonresidential real property that meets the following requirements:
Qualified production property does 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 Act defines a qualified production activity as the manufacturing, production or refining of a qualified product. It similarly defines the term "production" as limited to agricultural and chemical production. However, the Act limits a "qualified product" to any tangible personal property that is not a food or beverage prepared in the same building as a retail establishment in which such property is sold. In addition, the Act clarifies that an election to apply the 100% depreciation allowance for qualified production property is irrevocable (except in "extraordinary circumstances"). The Act also clarifies that a lessor cannot qualify for the 100% depreciation allowance, even if the lessee uses the property in a qualified production activity. Finally, the Act treats qualified production property as IRC Section 1245 property and also provides certain recapture rules if the taxpayer stops using such property in a qualified production activity. 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 substantially benefits certain taxpayers. Regulations and/or other guidance are needed to provide a more substantial framework for claiming the accelerated depreciation, tackling issues such as 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. The IRC Section 48D advanced manufacturing investment credit (AMIC) was enacted under the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act of 2022 to incentivize semiconductor and semiconductor equipment manufacturing in the United States. The AMIC provides a credit equal to 25% of the qualified investment in an advanced manufacturing facility (AMF) of an eligible taxpayer for a tax year. The IRC Section 48D credit does not apply to property whose construction begins after December 31, 2026. The Act increases the credit from 25% to 35% for property placed in service after December 31, 2025. The credit rate increase is a welcome development for taxpayers, particularly for those with planned investments that will go into service after December 31, 2025. Because the credit does not apply to property whose construction begins after December 31, 2026, it remains critical for taxpayers to evaluate whether they can meet one of the "beginning of construction" tests set forth in Treas. Reg. Section 1.48D-5 (i.e., the physical work test or 5% safe harbor). As ownership of an AMF is not a prerequisite for claiming the AMIC, certain taxpayers may consider making a qualified investment in another taxpayer's AMF to benefit from the credit rate increase. 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, the commencement of which 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 Act expands IRC Section 181 to aggregate qualified-sound-recording-production costs of up to $150,000 per tax year (but note that this would only apply for sound-recording productions that commence on or before December 31,2025 because IRC Section 181 expires for all productions that commence after December 31, 2025.) However, by being IRC Section 181 eligible, qualified-sound-sound-recording-production costs are eligible for the new 100% bonus depreciation provisions described above (provided the acquisition date and placed in service requirements are satisfied). This change applies to qualified sound recordings commencing production in tax years ending after July 4, 2025. 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 where applicable, would generally 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. 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 Act increases 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 Act reduces 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 are indexed for inflation for tax years beginning after 2025. IRC Section 179 permits businesses to currently deduct the full purchase price of qualifying equipment and software in the tax year the property is placed in service. The material increase in the expense amount may significantly impact strategic purchase decisions. For tax years beginning after December 31, 2017 and before January 1, 2026, an individual taxpayer may deduct (1) 20% of qualified business income from a partnership, S corporation or sole proprietorship; and (2) 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. Above certain taxable income levels, the deduction is not permitted for certain specified service trades or businesses (SSTBs) and is subject to limitation based on the W-2 wages paid by, and the property basis held by, the business. The 20% deduction may not be used in computing adjusted gross income and may be utilized both by non-itemizers and itemizers. "Qualified business income" is the net of domestic qualified items of income, gain, deduction and loss from the taxpayer's qualified business.
The Act expands phase-in deduction limitations for individuals and joint filers. Specifically, the Act increases the deduction limit phase-in range from $50,000 to $75,000 (non-joint returns) and $100,000 to $150,000 (joint returns). In addition, the Act establishes a new minimum deduction of $400 (adjusted for inflation) for taxpayers with at least $1,000 of qualified business income from one or more active trades or businesses. The Act excludes from the definition of "qualified business income" any amount that is allowable as a deduction under IRC Section 224(a) (the deduction for qualified tips) for the tax year. The Act also excludes the IRC Section 199A deduction from the limitation on itemized deductions under IRC Section 68. Except for the amendment related to IRC Section 224(a) (which is applicable to tax years beginning after December 31, 2024), the changes are effective for tax years beginning after December 31, 2025. The expansion of IRC Section 199A's inflation-adjusted phase-in deduction limitation and minimum deduction amount allow the provision to be applicable to more taxpayers with less risk of a taxpayer losing the benefit over time. The deduction's permanency in the IRC is a welcome addition for owners of passthrough entities. Under current law, taxpayers performing home construction contracts as defined in IRC Section 460(e)(5)(A), other than those subject to the so-called "small contractor exception" of IRC Section 460(e)(1)(B), are required to use the IRC Section 263A uniform capitalization rules. Additionally, both home construction contracts and small contractor exception contracts are not subject to required use of the percentage of completion method. The term "home construction contract" means any construction contract if 80% or more of the estimated total contract costs (as of the close of the taxable year in which the contract was entered into) are reasonably expected to be attributable to the building, construction, reconstruction, or rehabilitation of: (1) dwelling units contained in buildings (with each townhouse or rowhouse treated as a separate building) containing four or fewer units; and (2) improvements to real property directly related to such dwelling units and located at the site of such dwelling units. In contrast, "residential construction contracts" may be accounted for under either the percentage-of-completion method (PCM) or the percentage-of-completion capitalized cost method (PCCM), with 70% of contract income and costs reported on the percentage of completion method (and remaining costs accounted for under another permissible method. The term "residential construction contract" means any construction contract if 80% or more of the estimated total contract costs (as of the close of the tax year in which the contract was entered into) are reasonably expected to be attributable to the building, construction, reconstruction or rehabilitation of: (i) dwelling units (with no limitation to a building with four or fewer units) and (ii) improvements to real property directly related to such dwelling units and located on the site of such dwelling units. For purposes of clause (i), each townhouse or rowhouse is treated as a separate building. A principal change of the Act is to eliminate the separate "home construction contract" definitional category for purposes of the exception to required use of the PCM and to replace it with a broader definitional category. As part of the statutory revisions, the term "home construction contract" is replaced in IRC Section 460(e)(1) with "residential construction contract." Also, the small contractor exception of IRC Section 460(e)(1)(B) is modified to change the estimated time of completion from a two-year period beginning on the contract commencement date to a three-year period. This change also expands contracts that meet the small contractor exception. This change allows contractors more flexibility in accounting for exception eligible contracts by broadening the types of contracts that are not subject to required use of the PCM.
Document ID: 2025-1432 | ||||||
