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component materials of the depreciable property, the costs of
labor or other elements involved in its construction and
installation, or costs attributable to the acquisition of the
property. Sec. 1.174-2(b)(4), Income Tax Regs. An example in
subparagraph (4) is that of a taxpayer who undertakes to develop
a new machine for use in his business. The taxpayer expends a
total of $30,000 on the project, of which $10,000 represents the
actual costs of material, labor, etc., to construct the machine,
and $20,000 represents research costs that are not attributable
to the machine itself. In this example, the $20,000 research
costs are deductible, but the $10,000 costs are not deductible
and must be charged to the asset account (the machine).
In this case, petitioner's payment of $7,000 for the Porsche
engine represented the cost of an asset that was of a character
subject to an allowance for depreciation and that was used in
connection with research or experimentation. Since the $7,000
was for the acquisition of such an asset, that amount is not
deductible as a research or experimentation expense. Sec. 1.174-
2(b)(1), (2), (3), and (4), Income Tax Regs. All other expenses
petitioner incurred in connection with the enhancement of the
engine represented deductible research or experimentation
expenses, and, indeed, respondent has allowed those expenses as
deductions. For the $7,000 acquisition cost, however, the Court
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Last modified: May 25, 2011