You might buy the software off-the-shelf or have it customized for your business. Or you could develop it yourself if someone on your staff has the know-how.
Strategy: Feel the need for speed. The faster you can recoup your costs, the better. And, depending on your situation, you may have some options at your disposal.
The IRS issued definitive rules on deductions for computer software a few years ago. (IRS Revenue Procedure 2000-50) The IRS based the tax treatment on the manner in which you acquire the software. The five basic scenarios are:
1. Develop the software yourself. In this case, you can deduct the costs currently as long as you consistently follow this approach. Alternatively, you can amortize the costs over a 36-month or a 60-month period.
2. Buy off-the-shelf software. For tax years beginning before 2011, these costs can be deducted in the first year under the privilege. Otherwise, you can amortize the costs over 36 months.
3. Purchase software bundled with hardware. Generally, you depreciate the software as part of the hardware package over five years. But you can elect to separate the software costs and use a three-year depreciation period. Alternatively, you may write off the costs currently under Sec. 179.
4. Acquire highly specialized software as part of a business transaction. The tax law requires you to amortize the costs over 15 years.
5. Pay a leasing fee to use the software. This becomes an annual business expense, like rent, that you can deduct currently on your return. Note that you must treat software computer costs on a consistent basis. Therefore, if you’re making a switch (e.g., unbundling software from hardware), you’ll have to obtain IRS approval for an accounting change. Consult with your tax pro.
Tip: If you buy computer software with a useful life of less than one year, deduct the entire cost in the year it is placed into service.