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The proposed regulations would make the following five changes to the current Section 174 regulations: 


  1. Clarification that if expenditures qualify as research and experimentation expenditures, it is irrelevant whether a resulting product is ultimately sold or used in the taxpayer's trade or business (otherwise qualifying research and development expenditures will no longer be disqualified to the subsequent sale of the resulting product).
  2. Clarification that the Depreciable Property Rule (which states that R&D costs that result in the creation of depreciable property are disqualified) is an application of the general definition of R&D expenditures under the current regulations and is not to be applied to exclude otherwise eligible expenditures.
  3. Definition of "pilot model" as any representation or model of a product that is produced to evaluate and resolve uncertainty concerning the product during the development or improvement of a product, which includes a fully functional representation or model of a product, or a component of a product.
  4. Costs incurred after uncertainty concerning the development or improvement of a product has been eliminated are not eligible R&D expenses for purposes of Section 174. This is consistent with the longstanding rule under the Section 41 R&D credit regulations.
  5. Introduction of a "shrinking-back" provision, which allows for recognizing eligible R&D expenses for the development or improvement of a component part of a larger product, even though the development of the overall product has passed the point at which uncertainties have been resolved.  


The regulations are proposed to be effective for any tax year ending on or after the date they are finalized; however, taxpayers may rely on the proposed regulations until then. A public hearing has been scheduled for January 8, 2014.


To learn more about federal R&D credits please contact your local UHY LLP professional.