Acorn9

Section 174: R&D Capitalization After OBBBA (2026)

OBBBA restored immediate expensing of domestic R&D in 2026 — but foreign R&D is still capitalized over 15 years. The offshore trap, with a calculator.

By the Acorn 9 teamReviewed by a licensed CPA on the Acorn 9 team

Section 174 is the rule that decides whether your startup can deduct its R&D spending now or has to spread it out over years. From 2022 to 2024 it was the single most painful line in startup tax — forcing money-losing companies to report phantom income. In 2026, after the OBBBA overhaul, most of that pain is gone for US R&D. But there's a catch that hits exactly the startups with offshore engineering teams.

What Section 174 does

Section 174 governs the deduction treatment of research and experimental (R&E) expenditures. It is not the R&D tax credit — that's Section 41. Keep them separate:

  • §174 / §174A — how you deduct R&D costs (expense now vs. capitalize and amortize).
  • §41 — the R&D credit (a dollar-for-dollar tax reduction; see our R&D tax credit guide).

The two interact through the §280C rule, but they answer different questions.

The 2022-2024 disaster, and the 2026 fix

For tax years 2022 through 2024, the TCJA forced companies to capitalize R&E and amortize it — domestic over 5 years, foreign over 15 years — instead of deducting it immediately. For a startup whose burn was almost entirely engineering salaries, this manufactured phantom taxable income: you spent the cash, but you could only deduct a fraction of it, so you owed tax on money you'd already spent and didn't have.

The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, created a new IRC §174A that fixes this for domestic research:

  • Domestic R&D — fully deductible in the year incurred, for tax years beginning after December 31, 2024. Back to the pre-TCJA treatment.
  • Foreign R&D — no change. Still capitalized and amortized over 15 years.

So as of 2026, US-based research is immediately expensed again. The trap that remains is foreign.

The offshore trap (the part that still bites)

Foreign research must be capitalized over 15 years with a half-year convention — so in year one you deduct only 1/15 × 1/2 = 1/30 of the foreign spend. The other ~97% is recovered slowly over the next decade and a half.

For a startup with an engineering team in India, Eastern Europe, or Latin America, this is a live problem: every dollar of that team's R&D cost is almost entirely non-deductible this year, creating phantom income taxed at your rate. This is the same population — founders running a US entity with offshore engineering — that lives in the multi-state and cross-border compliance world.

See exactly what your split costs:

Interactive

Section 174 R&D expensing calculator

2026 rules (§174A). Domestic R&D is fully deductible; foreign R&D is capitalized over 15 years.

Enter your domestic and foreign R&D spend to see what is deductible now versus capitalized over 15 years.

Estimate only, for tax years beginning after Dec 31, 2024 (§174A). Foreign R&D uses a 15-year straight-line with a half-year convention (year-1 = 1/30). Ignores the §41 credit, the 2022-2024 transition rules, and state conformity. Not tax advice — confirm with your CPA. Sources: IRC §174 / §174A (OBBBA, Pub. L. 119-21), Rev. Proc. 2025-28.

What to do with your 2022-2024 capitalized balances

If you capitalized R&D under the old rule, OBBBA gives you transition options for the leftover balance:

  • Small businesses (average annual gross receipts of $31M or less over the prior three years) can amend 2022, 2023, and 2024 to apply §174A retroactively — pulling those deductions forward.
  • Everyone else can deduct the full remaining domestic unamortized balance in 2025, or split it 50/50 across 2025 and 2026.

The IRS laid out the mechanics in Rev. Proc. 2025-28 (August 2025). Which path is best depends on your income and loss position — this is a CPA conversation, not a default.

What counts as a §174 cost

Section 174 is broader than the §41 credit. It captures costs incident to developing or improving a product — including software development, explicitly treated as R&E under §174A(d) — where there's experimentation to resolve technical uncertainty: wages, supplies, contract research, and a reasonable share of overhead. It does not include routine data collection, quality control, ordinary G&A, or post-production refinement.

Because §174 is broader than §41, your §174 capitalizable base is usually larger than your credit-qualifying QRE base. Don't assume they're the same number.

Bottom line

For 2026, the §174 story is good news with an asterisk: domestic R&D is fully deductible again under §174A, so US-based startups are out of the phantom-income trap. But foreign R&D is still capitalized over 15 years, so if your engineering is offshore, model the drag before it surprises you at filing. Use the calculator above to see your domestic-vs-foreign split, settle your 2022-2024 transition election with your CPA, and remember §174 is the deduction — the R&D credit is a separate, stackable benefit.

This guide is informational only and is not tax advice. Rules reflect §174A for tax years beginning after December 31, 2024; state conformity varies and is not modeled. Sources: 26 USC §174 · IRC §174A as enacted by OBBBA (Pub. L. 119-21, July 4, 2025) · Rev. Proc. 2025-28 (transition guidance, August 2025). Reviewed by a licensed CPA on the Acorn 9 team.

FAQ

Frequently asked questions

What is Section 174?
Section 174 governs how a business treats its research and experimental (R&E) expenditures for income-tax purposes — whether it can deduct them immediately or must capitalize and amortize them over several years. It is separate from the Section 41 R&D tax credit: §174 is about the deduction (expense vs. capitalize), §41 is about the credit. A company can be affected by both in the same year.
Did OBBBA repeal Section 174 capitalization?
Partly. The One Big Beautiful Bill Act (signed July 4, 2025) created a new IRC §174A that restores immediate expensing of DOMESTIC research expenditures for tax years beginning after December 31, 2024. FOREIGN research is not restored — it must still be capitalized and amortized over 15 years. So the punishing TCJA capitalization rule is gone for US-based R&D but remains for offshore R&D.
How is foreign R&D treated under Section 174 in 2026?
Foreign (non-US) research expenditures must be capitalized and amortized over 15 years on a straight-line basis, with a half-year convention in the year incurred. That means in year one you can deduct only 1/15 × 1/2 = 1/30 of the foreign spend; the remaining ~97% is recovered slowly over the following years. For a startup with an offshore engineering team, this creates real phantom taxable income.
What happens to the R&D I capitalized in 2022-2024?
OBBBA provides transition relief for the balances you capitalized under the old TCJA rule. Small businesses (average annual gross receipts of $31 million or less over the prior three years) can elect to apply §174A retroactively by amending their 2022, 2023, and 2024 returns. Everyone else can deduct the full remaining unamortized domestic balance in 2025, or spread it 50/50 across 2025 and 2026. The IRS issued procedural guidance in Rev. Proc. 2025-28.
What counts as a research expenditure under Section 174?
Section 174 is broader than the Section 41 credit. It covers costs incident to the development or improvement of a product, including software development, that involve experimentation to resolve technical uncertainty — wages, supplies, contract research, and a reasonable share of overhead. Software development is explicitly treated as R&E under §174A. Routine data collection, quality control, and ordinary business expenses are not §174 costs.
What's the difference between Section 174 and the R&D tax credit?
They are two separate mechanisms that interact. Section 174 (now §174A) decides how you deduct R&D costs — immediately for domestic, over 15 years for foreign. Section 41 is the actual R&D tax credit, a dollar-for-dollar reduction of tax (or, for qualified small businesses, of payroll tax). The §280C rule coordinates the two so you don't double-count: claiming the credit requires either reducing your §174A deduction or electing a reduced credit. See our R&D tax credit guide for the credit side.