Supplies are one of the categories of qualified research expenses (QREs) that may be taken into account in computing the federal R&D tax credit under Section 41. But not every item purchased or used during a research project qualifies as a supply. This page explains, in general terms, when certain supplies may be taken into account and what the rules emphasize.
Qualified Research Supplies in Plain English
Under Section 41(b)(2), in-house research expenses include amounts paid or incurred for supplies used in the conduct of qualified research. The statute defines "supplies" as tangible property other than (i) land or improvements to land, and (ii) property of a character subject to the allowance for depreciation. The Treasury Regulations under Section 41 (§1.41-2) provide additional detail. The key idea is that supplies are tangible items consumed or used in the conduct of qualified research — not capital assets, land, or depreciable property.
What May Count as a Supply
Items that may count as supplies generally include tangible materials consumed or used up in the conduct of qualified research — for example, raw materials, components, test materials, and similar tangible property used in experimentation or testing that meets the four-part test. The Treasury Regulations also address amounts paid for the right to use computers in the conduct of qualified research, subject to specific rules. Whether a particular item counts depends on whether it meets the statutory definition and is used in qualified research.
What Generally Does Not Fit the Supply Category
Several categories generally do not fit the supply category:
- Land and improvements to land — expressly excluded by the statute.
- Property subject to depreciation — expressly excluded; capital equipment and depreciable property generally require different analysis and are not treated as supplies.
- General overhead — indirect costs that cannot be connected to specific qualified research generally are not automatically includable.
- Items used outside qualified research — supplies must be used in the conduct of qualified research.
The distinction between a supply and depreciable property is a common point of analysis: an item that is capitalized and depreciated generally is not a supply, even if it is used in a research project.
Prototype and Test Materials
Prototype and test materials can raise specific questions. Materials consumed in building and testing prototypes may, depending on the facts, be supplies if they are tangible property used in the conduct of qualified research and are not depreciable property. However, prototypes themselves can be capital in nature, and the treatment of prototype costs can depend on whether the prototype is depreciable property, is sold or used after testing, or is otherwise treated as a capital asset. The analysis is fact-specific, and the line between a consumed supply and a capital asset is not always simple.
Materials Used Across Multiple Activities
Where materials are used across both qualified research and other activities, the costs generally need to be allocated so that only the portion used in the conduct of qualified research is taken into account. An allocation that assigns the full cost of shared materials to qualified research, without support, generally is not appropriate. The allocation method should be supportable and consistent with the regulations and the Instructions for Form 6765.
Connecting Purchases to R&D Projects
As with other QRE categories, supplies must be connected to qualified research activities and business components. The IRS has noted that studies which fail to connect specific projects and activities to the underlying costs can fail to establish the required nexus. Purchase and use records that tie materials to specific qualified research projects tend to be more useful than generalized allocations prepared later. For more on the broader cost framework, see our page on qualified research expenses.
Documentation That May Help
Records that can help support supply claims include purchase orders, invoices, inventory and usage records, records of which projects and activities the materials were used in, and records distinguishing consumed supplies from capital items. Because the line between a supply and depreciable property can be fact-specific, records showing how an item was used — and whether it was consumed or capitalized — are particularly useful. For more, see our page on R&D tax credit documentation.
Common Misunderstandings
A few misunderstandings arise often:
- Every item bought for a research project is automatically a supply. (It is not — the statutory definition and the depreciation exclusion apply.)
- Capital equipment used in research is a supply. (It generally is not; depreciable property is excluded.)
- General overhead and indirect costs are automatically includable. (They generally are not without a supportable connection to qualified research.)
- The full cost of materials shared across activities can be assigned to qualified research. (An allocation is generally required.)
Key Takeaway
Certain supplies — tangible property other than land and depreciable property, used in the conduct of qualified research — may be taken into account as qualified research expenses. Not every item purchased for a project qualifies, capital and depreciable property generally require different analysis, and materials used across activities generally need to be allocated. Because these determinations are fact-specific, professional review is appropriate. For the broader cost framework, see our page on qualified research expenses.