These days just about every small business has at least one website, and many are going through upgrades as well as adding mobile sites and apps to their online strategy. Of course, all of this activity results in a number of different costs that must be accurately recorded and categorized. You might think the IRS would have clear guidelines on how to treat these costs, but they often lag behind the real world and so they left us with somewhat murky rules. To help shed some light I’ll cover some of the more common costs and options for treating them, particularly as it relates to deductions.
Purchased or Developed software overview
A key factor in determining how costs related to website development are treated is whether the website development involves Purchased or Developed software and the timing of when the cost is incurred.
It is considered Purchased when the seller is at economic risk if the website or software does not perform. An example would be the purchase of a WordPress template or a shopping cart that is bought and added to your website. [Is this correct?]
A developed website is defined as one in which the person or company that develops the website is NOT economically at risk if the website does not perform.
For developed websites, you have several options as it relates to deducting costs incurred. One is to deduct the cost in the year that it is paid or accrued, depending on your accounting method. As an alternative, you can write off the expenses over a three-year period.
Costs that are not classified as software expenses such as graphics and videos must be deducted over their useful life. If the useful life is one year or less, the expense is currently deductible.
The costs related to website content that can be classified as advertising are generally deductible in the year paid or accrued, depending on the accounting method used in your business. Content that changes on a regular basis is considered advertising.
If you go the purchased route, where the seller is at economic risk if it doesn’t perform, then the costs must be amortized (ratable deducted) over the 3-year period, beginning with the month in which the website is placed in service.
If you are planning to start a business, the website costs incurred before activating your business are generally not deductible until the business is terminated or sold. However, you can elect to deduct up to $5,000 of the costs in the year that your business starts and amortize the costs in excess of $5,000 over a period of 180 months (15 years), beginning with the month that your business starts.
If you are upgrading an existing site, how the costs are treated depends on what is being done. If you are like many business owners and have a WordPress site and your upgrades are primary to the front end, then generally the costs can be expensed in the year in which they were incurred. You might think of it concerning a billboard. Changing the face of a billboard does not have to be capitalized. Replacing the billboard itself would have to be.
The rules about the deduction and amortization of website development costs are complicated and lacking in clarity. I recently went through a website upgrade, so I am very familiar with the issues. If you have any questions, contact me.