Own Your Software Now: The Section 174 Change Is One Reason

The small businesses that pull ahead over the next few years will own the software that runs their operations. They'll stop paying per seat for tools that almost fit and start building systems shaped around how they work. If you've been waiting for a sign to make that move, this is it: start scoping now, before another renewal locks you in for a year.

Part of our evidence is the tax code. For the 2022 through 2024 tax years, domestic software development had to be spread over five years, while off-the-shelf software could qualify for bonus depreciation or Section 179. The July 2025 tax law reinstated the deduction for U.S. research costs, software development included, in the year they're paid or incurred. That removes a reason to put off building.

This isn't tax advice. We build software, and we aren't your accountant. Every tax detail below links to its source. Take them to a tax professional before you sign anything in December.

TL;DR

• We think small businesses should start owning their core software now, and the 2025 change in how software development is taxed is one piece of evidence.
• For tax years beginning after Dec. 31, 2024, Section 174A allows a deduction for domestic research costs, including software development, in the year they're paid or incurred, while foreign development is still spread over 15 years.
• Whether a developer's invoice counts as your own software development can turn on contract terms like financial risk and rights to the code, so take the contract to your accountant before you sign.
• In Kentucky, the state adds the federal 174A deduction back for tax years beginning in 2026, so the federal and state math won't match.

Key fact: The statute behind Section 174A treats "any amount paid or incurred in connection with the development of any software" as a research expense, deductible when paid or incurred or, by election, over at least 60 months (Public Law 119-21, Sec. 70302).

Why should you own your software instead of renting it?

Renting is the right call while a vendor's product fits your process. Once you're bending the process around the product, paying for workarounds and seats you barely use, we think it's time to own the system. Owned software does what your operation needs and stays yours when a vendor changes its pricing or its roadmap.

On timing, we'd start now. The federal rules look settled: the statute that created Section 174A sets no end date, and the IRS calls 100% bonus depreciation permanent. Waiting for a better moment means another year of renewals, and we don't see a better moment coming. If you're still sizing the budget, our Cincinnati cost guide breaks down what drives the number.

What changed in 2025 and 2026?

• July 4, 2025: Public Law 119-21 became law and created Section 174A.
• Tax years beginning after Dec. 31, 2024: Domestic research costs became deductible when paid or incurred; foreign research stays on a 15-year schedule.
• Jan. 14, 2026: The IRS issued interim guidance on bonus depreciation, which is 100% with no phase-down for property acquired after Jan. 19, 2025.
• July 6, 2026: The deadline passed for eligible small businesses, with average gross receipts at or under the 2025 limit of $31 million, to apply 174A retroactively to tax years beginning in 2022 through 2024 under Rev. Proc. 2025-28.
• Tax years beginning in 2026: The Section 179 limit is $2,560,000, reduced once Section 179 property placed in service tops $4,090,000.

Does paying an outside developer count as your own software development?

The IRS's most detailed guidance on contract research predates Section 174A, so treat this as background for your accountant. Treasury regulations cover research a contractor performs on your behalf. For depreciable property someone else builds for you, they count research costs as yours "only if made upon the taxpayer's order and at his risk," and a purchase under a performance guarantee doesn't qualify, with a narrow exception.

Notice 2023-63, written for the 2022 to 2024 rules, looks at the developer's side. A developer's costs are its own research costs if it bears financial risk under the contract or keeps a right to use the result. In the notice's example, a business orders a product from a U.S. contractor that makes no performance guarantee and gets no rights to it, and the business's payment counts as its own research expense. The notice's definition of a product includes software.

The IRS's 2025 Form 4562 instructions still point readers to it. How it applies to your contract under 174A is your accountant's call.

How is off-the-shelf software treated?

Off-the-shelf software, which the IRS defines as sold to the general public under a nonexclusive license and not substantially modified, qualifies for Section 179 and can also qualify for bonus depreciation. Without either, it's depreciated over 36 months. Notice 2023-63 adds that buying and installing purchased software, configuration included, isn't software development.

What should you ask your accountant before Dec. 31?

1. Whose research expense is this under our contract? Bring the draft. Point to who bears the risk if the build fails, whether there's a performance guarantee, who owns the code and where the developers work.
2. When does each cost count? A 174A deduction follows when costs are paid or incurred, which the tax code ties to your accounting method. Depreciation and Section 179 depend on when software is placed in service, which the IRS defines as ready and available for a specific use. Ask which timing rule applies to each piece, and whether the 60-month election suits you better than a current deduction.
3. Does a deposit paid before Dec. 31 count this year? A deposit for work done in 2027 is where your accounting method can change the answer.
4. Which parts are off-the-shelf? Licenses and setup on packaged tools may follow different rules than custom development. Ask how to split the invoice.
5. How does our state treat this? Ohio's tax department says Senate Bill 9, signed March 5, 2026, brought Ohio into conformity for tax year 2025, including the 2025 federal changes that affect Ohio taxes. Kentucky's House Bill 757 has taxpayers add back the federal 174A deduction for tax years beginning in 2026 and use the pre-2025 Section 174 amount instead. Elsewhere, ask about your state.

Where is this headed?

Our predictions as builders. Read them as opinion.

• By the 2027 filing season, we think accountants will ask to read software contracts before they're signed. The IRS's contract research tests turn on risk and rights, and both get fixed at signing.
• Our bet: by the end of 2027, "Where will the code be written?" sits beside the hourly rate on small-business shortlists. Domestic development can be deducted as paid or incurred while foreign work is spread over 15 years, and the IRS's own example ties the schedule to where the work happens.
• We expect development invoices to separate building from training and data conversion within a year, because IRS guidance excludes training and most data conversion from software development.
• We think owning core software stops being an enterprise move by 2028. With the build-versus-buy tax gap closed for U.S. work, cost and fit decide, and fit favors software made for your operation.

Should taxes decide when you build?

No. Tax timing can change when a deduction lands, and that's worth a conversation. It can't make the wrong system worth owning. Build the software your operation needs on the schedule the work needs, and let your accountant fit the tax year around it.

When you're ready to scope a build, here's how we approach application development.