Can Software Be Depreciated for Tax Purposes?

Depreciation is an accounting method that allows businesses to recover the cost of certain assets over their useful life. Businesses use depreciation to spread the expense of an asset over the years it generates revenue, which helps to match expenses with the income they produce. This practice reduces a business’s taxable income, thereby lowering its tax liability. While often associated with tangible items like machinery or buildings, software can also qualify as a depreciable asset for tax purposes under specific conditions.

Understanding Software Depreciation Eligibility

Software can be a significant investment for businesses, and its eligibility for depreciation depends on how it was acquired and its nature. To be depreciable, software must have a determinable useful life exceeding one year and be used in a trade or business or for income-producing activity.

For software purchased from an external vendor, a distinction exists between “off-the-shelf” and customized versions. Off-the-shelf software is readily available to the general public, sold under a non-exclusive license, and used in its original, unmodified form. This type of software is eligible for depreciation. Customized software, or software acquired from a contractor who bears the economic risk if the software does not perform as intended, can also be depreciated.

Software developed internally by a business for its own use can also be depreciated if it meets the criteria of having a determinable useful life and being used in the business. While previously expensed, recent tax law changes require capitalization and amortization for these costs. Software is not depreciable if it is intended for personal use or if its useful life cannot be determined.

Depreciation Methods and Recovery Periods

Once software is determined to be eligible, businesses can utilize various methods to depreciate its cost for tax purposes. The Modified Accelerated Cost Recovery System (MACRS) is the primary depreciation system used in the United States for most business property, including eligible software. MACRS assigns a three-year recovery period for most purchased software. This system allows for larger deductions in the earlier years of an asset’s life.

Beyond standard MACRS, businesses may also benefit from accelerated depreciation options. The Section 179 Deduction allows qualifying businesses to expense the full cost of eligible software in the year it is placed into service, rather than depreciating it over several years. For tax year 2025, the maximum Section 179 expense deduction is $1,250,000. This deduction begins to phase out dollar-for-dollar when the total cost of qualifying property placed in service during the year exceeds $3,130,000. Software must be off-the-shelf, used primarily for business (over 50%), and have a useful life exceeding one year to qualify for Section 179.

Bonus Depreciation provides another avenue for accelerated write-offs. This provision allows businesses to immediately deduct a percentage of the cost of qualified new and used software. While 100% bonus depreciation was available for property placed in service after September 27, 2017, and before January 1, 2023, the rate has been phasing down. For 2025, the bonus depreciation rate is 40%. Bonus depreciation is particularly useful for businesses with capital purchases exceeding the Section 179 phase-out threshold.

Special Rules and Considerations for Software

Certain types of software and software-related expenses have distinct tax treatments that differ from general depreciation rules. Software-as-a-Service (SaaS) subscriptions, for instance, are treated as deductible operating expenses rather than depreciable assets. This is because with SaaS, businesses pay a recurring fee for access to the software without owning the underlying asset. The taxability of SaaS can vary by state.

Software that is embedded within hardware is another unique case. When software is an integral part of a hardware asset, such as an operating system on a computer or firmware in a specialized machine, its cost is depreciated along with the hardware. The depreciation schedule for such embedded software follows that of the hardware it controls, over a five-year recovery period for computer equipment.

Research and Development (R&D) costs for software development also have specific tax rules, which underwent significant changes with the Tax Cuts and Jobs Act (TCJA) of 2017. Previously, businesses could often immediately deduct these expenses. However, for tax years beginning after December 31, 2021, businesses are required to capitalize specified research and experimentation (SRE) expenditures, including software development costs. These capitalized costs are then amortized over a period of five years for domestic R&D activities and 15 years for foreign R&D activities.