What Are R&E Expenses? Definition and Tax Treatment

Research and Experimentation (R&E) expenses represent investments businesses make to drive innovation and develop new products or processes. Understanding how to properly identify and treat R&E expenses is important for accurate financial reporting and effective tax planning. The rules surrounding these expenditures directly impact a company’s financial statements and its tax obligations.

Defining R&E Expenses

R&E expenses are defined as costs incurred in connection with a taxpayer’s trade or business that represent research and development in an experimental or laboratory context. The purpose of these activities is to discover information that eliminates uncertainty concerning the development or improvement of a product. Uncertainty exists when available information does not clearly establish the capability, method, or appropriate design for developing or improving the product.

These expenditures involve activities aimed at gaining new knowledge or overcoming technical challenges, not routine testing or quality control. The nature of the activity, rather than the success or failure of the project, determines whether an expense qualifies as R&E. This includes efforts to develop or improve a product, process, formula, invention, software, or technique. The costs must be incurred “in connection with” a trade or business, meaning there must be a realistic prospect that the efforts will result in a trade or business.

Identifying Qualified R&E Activities and Costs

Qualified R&E activities involve a systematic process of experimentation aimed at achieving a new or improved function, performance, reliability, or quality for a business component. This includes developing new products, improving existing products, or creating new production processes. These activities must be technological in nature and undertaken to eliminate technical uncertainty.

Expenses that can be included as R&E costs encompass various direct and indirect expenditures. These include wages paid to employees directly involved in R&E activities, or those supervising or supporting such research. Costs of supplies used or consumed in the research process, such as laboratory materials, also qualify. Depreciation of equipment or buildings used directly in R&E projects is another inclusion.

Other qualifying expenses include costs of obtaining a patent, such as attorney’s fees, and certain operation and management costs directly supporting R&E activities like rent, utilities, and insurance. Software development costs are also categorized as R&E expenditures.

Accounting and Tax Treatment of R&E Expenses

The tax treatment of R&E expenses changed for tax years beginning after December 31, 2021. Previously, businesses could often immediately deduct R&E expenses. However, under the Tax Cuts and Jobs Act of 2017, R&E expenditures must now be capitalized and amortized over a specified period.

For domestic research, these costs must be capitalized and amortized over a five-year period, starting mid-year. Foreign research R&E expenditures must be capitalized and amortized over 15 years, also starting mid-year. This mandatory capitalization applies even if a company does not claim the R&D tax credit.

Capitalizing expenses rather than deducting them immediately means a business’s taxable income may increase in the short term, leading to higher tax liabilities. For example, a $1 million domestic R&E expense would only yield a $100,000 deduction in the first year under the five-year amortization rule, resulting in a significantly reduced initial deduction. If property related to R&E expenditures is disposed of, retired, or abandoned, amortization must continue over the original period.

Recent legislative developments, such as the One Big Beautiful Bill Act (OBBBA) enacted in July 2025, have reinstated the option for full expensing of domestic R&E expenditures for tax years beginning after December 31, 2024. Businesses can now choose to deduct these domestic costs immediately or elect to capitalize and amortize them over at least 60 months. Foreign R&E expenditures continue to be subject to the mandatory 15-year capitalization and amortization. The OBBBA also includes transition rules allowing for the deduction of previously capitalized, unamortized domestic R&E expenses from 2022 through 2024.

Distinguishing R&E from Other Business Expenses

Differentiating R&E expenses from other business expenditures is important due to their distinct accounting and tax treatments. R&E activities are geared towards eliminating technical uncertainty in developing or improving a product or process, setting them apart from routine operational costs. For example, routine quality control testing or inspection of materials for quality assurance do not qualify as R&E. These are considered ordinary and necessary business expenses deductible under other sections of the tax code.

Market research, consumer surveys, or management studies are excluded from R&E because they do not involve experimental or laboratory research. General administrative activities, such as payroll or human resources, which only indirectly support R&E, are also not considered R&E expenditures. While depreciation of assets used in R&E can be included, the cost of acquiring land or depreciable property itself is not an R&E expense. Understanding these boundaries helps businesses properly classify costs for accurate financial reporting and tax compliance.