Can I Use Bonus Depreciation When Purchasing a Software Business to Offset Gains?

Thanks for the explanation! Quick follow-up: if most of the software was internally developed by the company I'm buying, does that change how it qualifies for bonus depreciation? Also, is there a limit to how much of the purchase price I can reasonably allocate to software assets before the IRS might question it?

Internally developed software is treated differently for tax purposes. If the software was created by the company you're purchasing, you'd be buying the results of their development efforts, which means it's considered purchased software from your perspective, not self-created software. This distinction is important because purchased software can qualify for bonus depreciation. For allocation amounts, there's no fixed percentage limit, but the allocation needs to be reasonable and reflect fair market value. Having a qualified third-party valuation can help support your allocation if the IRS questions it. I recommend getting a professional software valuation as part of your due diligence process to substantiate the allocation in your purchase agreement.

How accurate is their analysis though? My accountant always tells me these online tools miss important nuances that only experienced CPAs understand. Did you have any issues with their recommendations when filing?

I'm considering using them but worried about privacy. How do they handle sensitive financial documents? And do they help with the actual filing or just provide the analysis?

Their analysis was surprisingly detailed - it caught several nuances my previous accountant had missed regarding specific allocations for SaaS business assets. The recommendations aligned with what my CPA ultimately filed, but it gave me confidence to push back when my accountant initially took a more conservative approach. No issues with the filing, and I ended up with substantially higher first-year deductions. Regarding privacy concerns, they use bank-level encryption for all document uploads and their privacy policy is very clear about not sharing data with third parties. They provide the analysis and documentation, which you can then give to your tax preparer - they don't file for you, but they give you everything needed to maximize your position with whoever handles your filing.

Wait, how does this actually work? The IRS puts you on hold for hours intentionally - there's no way to skip the line. Sounds like a scam to me.

Seems fishy. Even if you get through, most IRS agents give very general answers and won't provide specific guidance on complex situations like business acquisitions. Did you actually get useful information?

It doesn't skip the line - they have technology that dials in and navigates the phone system, then stays on hold so you don't have to. When a real person answers, you get a call and are connected directly to the agent. It's basically outsourcing the hold time. I absolutely got useful information. The agent I spoke with was from the business tax division and walked me through the specific documentation requirements for substantiating software asset allocations. They referenced the relevant code sections and even emailed me a publication with highlighted sections about bonus depreciation for acquired software assets. Not all agents are created equal - some are incredibly knowledgeable about specialized areas.

Could you explain more about the recapture risk? I'm considering a similar acquisition but might need to sell in 3-4 years. How would the recapture be calculated?

The recapture risk comes from Section 1245 recapture rules. Essentially, when you sell business assets that you've depreciated, the portion of your gain that represents the depreciation you've taken is "recaptured" as ordinary income rather than getting the more favorable capital gains treatment. For example, if you allocate $500,000 to software assets and take bonus depreciation on the full amount, then sell the business three years later with those software assets valued at $400,000 in the sale, you'll have to recapture the difference between your adjusted basis (potentially $0 after bonus depreciation) and the sale allocation to those assets ($400,000). That $400,000 would be taxed as ordinary income, not capital gains.

Quickbooks to QBO migrations often have problems with fixed asset and depreciation records. I had to manually recreate several depreciation schedules after switching. Better to export detailed fixed asset reports before migrating and verify everything after. Several of my clients had basis tracking issues after migration.

This is exactly the kind of detail I was hoping someone would mention! The "placed in service" requirement is something my advisor glossed over, but it sounds like it could be a major issue if not handled correctly. If I'm acquiring a SaaS business that's already operational, would the software assets automatically be considered "placed in service" on the closing date? Or do I need to take specific steps to document this? I'm worried about any gaps between closing and when I can legitimately claim the assets are available for use under my ownership. The point about getting a written opinion is well taken - given the amounts involved and the timing with my capital gains, I definitely don't want to trigger an audit over something that could have been structured better from the start.

For an already-operational SaaS business, the software assets are typically considered "placed in service" on the closing date, assuming you're acquiring a going concern that continues operating without interruption. The key is maintaining continuity of operations - if the software continues serving customers and generating revenue immediately after closing, you should be good. However, document everything carefully. Get representations in your purchase agreement that the software systems are fully operational and revenue-generating as of closing. Take screenshots of active user dashboards, revenue reports, and system status on closing day. If you're making any significant changes to the software architecture or integrating with your existing systems, document the timeline to show the original software remained operational. One trap to watch out for: if you plan to migrate the software to new servers or make substantial modifications post-closing, the IRS might argue that creates a "new" asset with a different placed-in-service date. Keep the original systems running as acquired, at least through year-end, even if you're planning changes for next year. The written opinion advice is spot-on. With substantial gains to offset, the IRS will likely scrutinize both the timing and the asset allocation percentages. Better to have professional coverage upfront than explain it during an audit.

This is a really important point about state conformity that I hadn't considered! I'm in California, so this could definitely complicate things. Do you know if California has updated their conformity rules recently, or are they still several years behind on bonus depreciation? Also, regarding the internal use software distinction - how do I determine what qualifies as internal use versus customer-facing? The SaaS platform obviously serves customers, but there's probably backend administrative software for things like billing, customer management, etc. Would those components need to be separated out for different depreciation treatment? I'm starting to realize this is even more complex than I initially thought. The federal tax benefit might not be worth it if it creates years of complicated state tax adjustments and compliance issues.

California still hasn't fully conformed to the federal bonus depreciation rules - they're typically several years behind and often require addback adjustments on your state return. For 2024, California generally requires you to add back the excess federal bonus depreciation and then deduct it over the normal depreciation period, creating ongoing tracking complexity. For the internal use software distinction, customer-facing applications (your core SaaS platform, user interfaces, APIs that customers access) generally get more favorable treatment than internal administrative systems. Backend billing software, HR systems, accounting platforms, and internal dashboards would typically be classified as internal use software with different depreciation rules - usually 3 years straight-line rather than being eligible for bonus depreciation. You'll need to work with your valuation specialist to properly segregate these in the purchase price allocation. The good news is that most of the value in a SaaS business should be in the customer-facing platform, but you're right that this adds another layer of complexity. Given California's non-conformity, you might want to model both the federal benefit and the multi-year state compliance costs. Sometimes the administrative burden and potential audit risk outweigh the first-year federal tax savings, especially if you're already dealing with significant short-term gains.

The earnout structure is a brilliant approach that I hadn't considered! It really does help demonstrate legitimate business intent while still capturing the immediate tax benefits. I'm curious about the mechanics though - when you structure an earnout, how do you handle the depreciation on the contingent portion? For example, if you pay $2M at closing with a potential $1M earnout based on performance metrics, can you only depreciate the software allocation from the $2M closing payment? Or can you estimate the full value and adjust later when the earnout is determined? This seems like it could get complicated with basis adjustments if the earnout doesn't fully materialize. Also, your point about electing out of bonus depreciation on certain assets is interesting. In what scenarios would that make sense? I would think maximizing the first-year deduction is always better, especially when trying to offset short-term capital gains.