Beginning in 2022, businesses are now required to capitalize specified research and experimental expenditures  (“SRE expenditures“) and amortize (deduct) them over time.  Expenditures attributable to domestic research are amortized over five years and expenditures attributable to foreign research are amortized over 15 years.   SRE expenditures are generally research and development costs in an experimental or laboratory sense for product development or improvement and include software development costs.

If the property with respect to which the SRE expenditures are being amortized is sold, the business is not allowed to deduct the unamortized expenditures or use them to offset gain on the sale but must continue to deduct the amortization over the relevant period (i.e., 5 or 15 years).  For companies that have substantial unamortized SRE expenditures this could result in the practical loss of meaningful deductions if the company sells its business in an asset sale.  If, for example, the company is in its second year of a five-year amortization period, it will be required to deduct that amortization over the following three years.  Having sold its business, it may not have any income against which to apply the deductions.

Guidance released earlier this year in Notice 2023–63 provides some relief, allowing corporations that cease to exist i.e., dissolve (in a taxable transaction) to deduct the unamortized expenditures in its final tax year.  Accordingly, if the selling corporation can be liquidated in year of sale, it will be able to use the unamortized expenditures to offset sale gain.  If liquidation in the year of sale is not an option or the selling company is not a corporation, deferring payment of a portion of the purchase price might allow a seller to use unamortized expenditures more fully.  In addition, a seller’s receipt of equity of the buyer or an earnout may provide an opportunity to utilize the unamortized losses depending upon the timing and amount of the future income or gain.

Bottom Line:  For companies with substantial unamortized SRE expenditures, careful planning may be required to prevent the loss of those deductions.

“Every day I get up and look through the Forbes list of the richest people in America. If I’m not there, I go to work.” —Robert Orben