Deducting the Cost of Computer Software

        Computer systems are virtually indispensable in a wide variety of businesses, and an increasingly expensive component of these systems is the software. Therefore, here's a quick review of how you may be able to write off the software expenses you incur in your business.

        If the software is included in the purchase price of the computer itself, it generally does not have to be broken out separately. The entire cost of the machine and the software it comes with may be depreciated over five years, or expensed in full in one year, subject to the annual limit, generally $24,000 in 2001, for all expensed property you begin to use in your business that year. However, if the price is stated separately, the software component will probably come within rules that allow a three-year write off.

        If you have bought additional software, it is fully deductible in the year of purchase if it has a useful life of one year or less. This may apply, for example, to software that is upgraded annually or for which a new edition must be issued each year for the user to stay current.

        If the additional software you have bought has a useful life longer than one year, it can be depreciated over three years if it is bought "off the shelf,'' i.e. is for sale to the general public and is not substantially modified (customized) for you. Even if the software isn't "off the shelf" because it has been designed or specifically modified for you, or you have an exclusive license to use it, it can be written off over three years if it was bought for use in your regular business, and was not obtained as part of acquiring another business. However, if the software is customized and was received in a business acquisition, the cost of the software must be amortized over 15 years.

       These are the rules that generally apply to software acquired after August 10, 1993. Note that "software" under these rules generally does not include databases, unless the database is in the public domain and is incidental to the operation of deductible computer software.

        If instead of buying "off the shelf" or customized software, a business writes or develops its own software internally, the research and development costs can be written off currently, or can be written off over five years or any shorter useful life that can be clearly established. This is true whether or not the software is patented or copyrighted, and whether or not you also sell it to others. But if you choose to fully deduct these costs, generally you must do so consistently each year.

        If you think that the foregoing discussion of what are complex rules may apply to your business, please do not hesitate to contact us to see how best to handle your past as well as present software purchases.

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