Rev. Proc. 69-21

Section 1. Purpose.

The purpose of this Revenue Procedure is to provide guidelines to be used in connection with the examination of Federal income tax returns involving the costs of computer software.

Sec. 2. Background.

For the purpose of this Revenue Procedure, "computer software" includes all programs or routines used to cause a computer to perform a desired task or set of tasks, and the documentation required to describe and maintain those programs. Computer programs of all classes, for example, operating systems, executive systems, monitors, compilers and translators, assembly routines, and utility programs as well as application programs are included. "Computer software" does not include procedures which are external to computer operations, such as instructions to transcription operators and external control procedures.

Sec. 3. Costs of Developing Software.

.01 The costs of developing software (whether or not the particular software is patented or copyrighted) in many respects so closely resemble the kind of research and experimental expenditures that fall within the purview of section 174 of the Internal Revenue Code of 1954 as to warrant accounting treatment similar to that accorded such costs under that section. Accordingly, the Internal Revenue Service will not disturb a taxpayer's treatment of costs incurred in developing software, either for his own use or to be held by him for sale or lease to others, where:

1. All of the costs properly attributable to the development of software by the taxpayer are consistently treated as current expenses and deducted in full in accordance with rules similar to those applicable under section 174(a) of the Code; or

2. All of the costs properly attributable to the development of software by the taxpayer are consistently treated as capital expenditures that are recoverable through deductions for ratable amortization, in accordance with rules similar to those provided by section 174(b) of the Code and the regulations thereunder, over a period of five years from the date of completion of such development or over a shorter period where such costs are attributable to the development of software that the taxpayer clearly establishes has a useful life of less than five years.

Sec. 4. Costs of Purchased Software.

.01 With respect to costs of purchased software, the Service will not disturb the taxpayer's treatment of such costs if the following practices are consistently followed:

1. Where such costs are included, without being separately stated, in the cost of the hardware (computer) and such costs are treated as a part of the cost of the hardware that is capitalized and depreciated; or

2. Where such costs are separately stated, and the software is treated by the taxpayer as an intangible asset the cost of which is to be recovered by amortization deductions ratably over a period of five years or such shorter period as can be established by the taxpayer as appropriate in any particular case if the useful life of the software in his hands will be less than five years.

Sec. 5. Leased Software.

Where a taxpayer leases software for use in his trade or business, the Service will not disturb a deduction allowable under the provisions of section 1.162-11 of the Income Tax Regulations, for rental.

Sec. 6. Application.

.01 The costs of development of software in accordance with the above procedures will be treated as a method of accounting. Any change in the treatment of such costs is a change in method of accounting subject to the provisions of sections 446 and 481 of the Code and the regulations thereunder.

.02 For taxable years ending after October 27, 1969, the date of publication of this Revenue Procedure, the Service will not disturb the taxpayer's treatment of software costs that are handled in accordance with the practices described in this Revenue Procedure.

.03 For taxable years ending prior to the date of publication of this Revenue Procedure, the Service will not disturb the taxpayer's treatment of software costs except to the extent that such treatment is markedly inconsistent with the practices described in this Revenue Procedure. For the purpose of applying the preceding sentence, the absence of any formal election similar to that required by section 174 of the Code, or the amortization of capitalized software costs over a period other than the five-year period specified in section 174(b) of the Code, will not characterize the taxpayer's treatment of such costs as markedly inconsistent with the principles of this Revenue Procedure.

¹ Also released as Technical Information Release 1021, dated October 7, 1969.