Computer Software Depreciation is a Home Business Tax Deduction
Computer Software can be Depreciated over a 36 month period or over the same period as the computer it was included with, but there are exceptions in which you can expense it all in the first year. Some software is eligible for the Section 179 deduction.
Software for business use is fully deductible via software depreciation.
Examples of software that would qualify includes; property management software, accounting software, small business software, etc… The IRS allows you to depreciate them as business related expenses via software depreciation.
If you have a web business and use Photoshop, Dreamweaver, etc.. you can deduct these as home business expenses via software depreciation.
Pre-Installed on Computer vs. Purchased Separately
If you purchase a computer for your business and the software is included in the price of the computer without being separately identified, the charge for the software must be consistently treated as part of the cost of the computer. This means that it must be depreciated the same as the computer. If the price of the software is separately stated, or the software is purchased separately, it is supposed to be amortized over 36 months, beginning the month the software is placed in service. There is an exception noted below.
Time-frame for Software Depreciation
If you buy software for business use, such as a database or spreadsheet program, the treatment of the cost depends on how you use the software in question. If you use it for a year or less you can deduct the cost as a business expense for that year. An example would be an annual tax program like TurboTax. If the useful life in your business exceeds a year you will need to depreciate it over 36 months. There is an exception though. The exception applies to “off-the shelf” software. Off-the-shelf computer software is eligible for first year expensing if it:
- Is readily available to the general public.
- Is not subject to an exclusive license.
- Has not been substantially changed or modified.
Off-The Shelf Software Eligible for Section 179 Deduction
Off-the shelf software includes any program designed to cause a computer to perform a desired function. Note that a database or similar item is not considered computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software. The IRS defines “off-the-shelf software” as software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified. This type of software is eligible for the section 179 first year expensing deduction.
You cannot deduct computer software by making a section 179 election (the exception being noted above), because software is “intangible property”, and the section 179 election only applies to tangible personal property. Intangible property is something that lacks a physical existence that does not have value itself, but represents something else. Stocks and bonds are examples of intangible property, as is computer software.
If the three tests above are met however, software that is purchased in 2013 is eligible for first-year expensing. You may also depreciate the cost over 36 months if you choose.
Software Depreciation Example
Example: You purchase Microsoft Office Professional Edition for $300 and load it onto your computer on July 1, 2014. If you use it entirely for a business purpose the amount that is deductible each year for software depreciation is:
|2014||$50 ($300 x 6/36)|
|2015||$100 ($300 x 12/36)|
|2016||$100 ($300 x 12/36)|
|2017||$50 ($300 x 6/36)|
Software That Becomes Obsolete
As stated above, the software must be depreciated over 3 years but software often does not remain usable for 3 years; it becomes obsolete. If this happens to your software, you can deduct the balance of its cost in the year it is no longer usable. Using the example above, let’s assume the software becomes obsolete in 2015 you can deduct the balance of the cost, $250 ($300 software cost – $50 2013 Software Depreciation Deduction) in 2015.
For more information on Software Depreciation, you can read IRS Publication 946; How to Depreciate Property.