IRS Clarifies Coordination of Section 174 Method Changes and Accelerated Recovery Elections

The IRS recently issued Revenue Procedure 2026-32, providing welcome clarification for taxpayers that improperly deducted domestic research and experimental (R&E) expenditures in tax years 2022 through 2024 and are now seeking to align with the capitalization requirements enacted under the Tax Cuts and Jobs Act. The guidance confirms that taxpayers may, in the same 2025 taxable year, both file an accounting method change to capitalize previously incurred domestic R&E expenditures and elect the recovery of unamortized amount method available under the One Big Beautiful Bill Act (OBBBA) transition rules.

Importantly, the IRS also addressed how the related Section 481(a) adjustment must be treated. Under the general accounting method change rules, a positive §481(a) adjustment would ordinarily be spread over four years beginning with the year of change under Rev. Proc. 2015-13. Revenue Procedure 2026-32 displaces that default for domestic R&E method changes by requiring the §481(a) adjustment to be recognized over the same period the taxpayer selects for recovering the remaining unamortized domestic R&E balance — either entirely in the first taxable year beginning after December 31, 2024, or ratably over two years. The matching rule thus eliminates the mismatch that would otherwise arise if the recovery deduction and the offsetting income inclusion ran on different timelines — producing a same-year offset for prior-year domestic R&E expenditures while still allowing an immediate deduction for qualifying expenditures incurred in 2025 under IRC §174A.

Example: Section 174 Method Change and Recovery Election

Assume a taxpayer improperly deducted domestic R&E expenditures incurred during 2022 through 2024 and determines that it would have had an $800,000 unamortized domestic R&E balance as of January 1, 2025, had the expenditures been properly capitalized. In 2025, the taxpayer files an accounting method change to correct the prior treatment, elects the recovery of unamortized amount method under the OBBBA transition rules, and begins immediately deducting domestic R&E expenditures incurred in 2025 under IRC Section 174A.

As part of the accounting method change, the taxpayer reports a positive Section 481(a) adjustment of $800,000. If the taxpayer elects to recover the entire $800,000 remaining unamortized balance in 2025, Revenue Procedure 2026-32 requires the full $800,000 positive Section 481(a) adjustment to also be recognized in 2025. The accelerated deduction and corresponding Section 481(a) adjustment effectively offset one another, resulting in a largely tax-neutral outcome for the prior-year domestic R&E expenditures. However, the taxpayer may still immediately deduct qualifying domestic R&E expenditures paid or incurred during 2025 under Section 174A, providing a current-year benefit.

Procedural Requirements

Accounting Method Change for 2022-2024 Domestic R&E Expenditures (DCN 265)

Taxpayers seeking to correct the treatment of domestic R&E expenditures incurred in 2022, 2023 and/or 2024 must file Form 3115 under DCN 265. The filing should include a description of the expenditures being treated as specified research or experimental (SRE) expenditures, the taxable years involved and a statement indicating that the taxpayer is making a modified Section 481(a) adjustment that only reflects expenditures paid or incurred after December 31, 2021.

Immediate Deduction of 2025 Domestic R&E Expenditures and/or Recovery of Unamortized Amounts (DCN 273)

Taxpayers electing to immediately deduct domestic R&E expenditures beginning in 2025 under Section 174A and/or adopt the recovery of unamortized amount method are not required to file Form 3115. Instead, they must attach a statement to their timely filed federal income tax return identifying DCN 273 and documenting the applicable elections. The statement must indicate whether the taxpayer is electing to recover the remaining unamortized balance entirely in the first taxable year beginning after December 31, 2024, or ratably over the two-year recovery period provided under the OBBBA transition rules.

Key Takeaway

Revenue Procedure 2026-32 resolves a significant area of uncertainty by confirming that taxpayers may simultaneously correct noncompliant Section 174 treatment for 2022 through 2024 while electing accelerated recovery of remaining unamortized domestic R&E expenditures. The guidance also coordinates the timing of the related Section 481(a) adjustment, providing taxpayers with a clearer roadmap for implementing the new Section 174A and OBBBA transition relief provisions beginning in 2025.

Taxpayers considering a Section 174 method change or accelerated recovery election should evaluate how Revenue Procedure 2026-32 may affect their specific circumstances. Withum’s tax professionals can help assess available options and assist with implementation and compliance requirements.