If you’re in the business of buying and selling domains and websites, as well as operating these websites for a profit then using the correct accounting treatment is important. I have also noticed that the amount of information available on the internet regarding the proper treatment is difficult to come by and, so far, I have not found a detailed or consistent method for this type of business.
Additionally I must state that the following is simply my opinion and may or may not relate directly to your domain/website business. From my research, accounting for web-based businesses have not been discussed at length; I have developed the following series of articles through my experiences while both owning and running several websites and domains.
This series of articles will attempt to clarify and create a standard set of principals that business owners and accountants should use when relating to this relatively new market. Feel free to contact me in relation to this article series to give me your opinion either on LinkedIn or through my contact form.
The proper treatment of Domains and Websites on your Chart of Accounts
My first article on this topic will discuss how you should treat the purchase of domains and websites on your chart of accounts. Many times, business owners who use the cash-basis method of accounting will ‘write-off’ the purchase of these items as expenses, when in fact they should be capitalized and either amortized or depreciated over a useful life.
Hosting costs, on the other hand, are treated as expenses by both the cash-basis and accrual businesses. However, both cash-basis and accrual should deduct only the prepaid hosting costs that occurred during that time period; my personal belief is that business owners should treat hosting costs the same as they would Rent or Insurance: The IRS does not allow businesses to deduct these expenses in advance of when they occur. Thus if you pre-pay for 3 years of hosting costs on January 1, 2014 to receive a discount, you can only deduct 1/3 of those expenses in 2014, and another 1/3 in 2015 and 1/3 in 2016.
Before going any further let’s separate the accounting treatment of the domain itself from the website, which in my view are two totally different assets even though they are very much so related.
Let’s say you go to GoDaddy.com and buy a new domain for $9.99/year–how is that any different from when you buy a similar but different domain on the GoDaddy.com Auction for $99.99? When you “buy” a new domain from GoDaddy you’re really just “renting” it at a yearly price with the option to renew each year. If you don’t renew the rent each year, you forfeit your right to the domain and GoDaddy will resell it to someone else (after wiping it clean of any improvements you make). Thus the accounting treatment is similar to that of the hosting I described above–if you prepay for 2, 3, 4 or more years up front, you should only deduct the cost of the rent 1 year at a time.
When you purchase a domain from the Auction block, you’re essentially paying for the additional intangible value to that domain (some domains are worth way more than others). Even though you are paying $99.99 for the domain, you still have to pay GoDaddy.com (or similar site) the $9.99/year in addition to this auction price to manage the domain. So the $99.99 you’re paying to buy the domain from the Auction is similar to that of “GoodWill” which should be amortized over a 180 month (15 year) period. This same treatment holds true if you purchase the domain from a friend, reseller or acquire it via trade.
Websites You Build From Scratch
If you buy a domain new, then you will expend costs to acquire content, designs, logos, coding, etc that add up to create a “website.” These are all similar to the construction materials that go into a leased office building and, when the website is completed, must be depreciated over the useful life of the website. A ‘completed’ website is a term that is wide open to interpretation, but in my opinion I think it would mean when you are ready to do any of the following: 1) You have started to buy/sell advertising for/on it, 2) You’ve placed affiliate/referral links on the site to start earning revenue or 3) You’ve placed the website up for sale. At this time, all the costs that have gone into the website (include paid labor but not the value of your own time), become added into the website and becomes its original basis.
Once the website has been ‘completed,’ you can now depreciate it over a useful life. How long? Again this is open to debate (I am not aware of any IRS clarifications on this) but your reasonable options are 3 years, 5 years or 7 years–I feel the best treatment is either on a 3 year of 5 year time span. For most of my clients, I choose a 3 year treatment because of the relatively short-term trends that the internet tends to create. On the other hand, if you prepay a domain for 5 years in advance I would have difficulty arguing your intention on the value of the website was for less than that amount of time.
Any additional expenditures for the website going forward must either be added to the basis of the website or deducted in the current tax year. What determines the treatment? Essentially if you add a new set of content that is expected to extend the useful life of the website more than 1 year, then it must be capitalized and depreciated over a new 3 year (or 5 year if applicable) time span. However if you’re releasing daily content (news, blog posts, tips and tricks, etc) then these don’t extend the useful life of the website enough that they should be depreciated, even if in the future you receive a form of revenue from these posts.
Websites You Purchase Already ‘Complete’
If, when buying the domain from a 3rd party, you receive a website in addition then you must attribute some of the purchase price to the basis of the website. This basis then gets depreciated over a 3 year or 5 year time span. Just like when you create a website, any additions you make that increases the useful life of the website must be capitalized and depreciated over a new time span.
When You Sell A Website And Domain
Once you dispose of the domain and website, either by sale or refusal to renew (selling price = $0), you recognize a gain or loss based on the difference of the selling price and the adjusted basis (original purchase price minus amortization) of both the domain and website separately. If you bought the domain new then your basis in the domain is $0. Note that this value is different from the website itself and, when you sell both a domain and website together, you must portion the amount received separately to both the domain’s and the website’s adjusted basis.
Why Is This So Complicated?
Mainly because the IRS has released relatively no information on how business owners should account for websites and domains as assets that depreciate. They don’t fit neatly into the predefined terms of neither a “Fixed Asset” nor an “Intangible Asset” and are really a hybrid of the two. Domains and websites “exist” and have a “defined value” but only in cyberspace.
I don’t expect anything to change going forward either until someone who operates a website business that then gets audited and makes the case public.
Do I Have To Follow This Treatment?
As I mentioned there is little in the way of precedent when it comes to treating your websites and domains. There is one tax benefit that I have not mentioned yet so please check with your own tax advisor on this: When you sell a capital asset, you get special gains treatment–you don’t have to pay self-employment tax on it. Thus if you sold a website and you treated it like a depreciated asset and were fortunate enough to make $30,000, you would only pay income tax and not self-employment tax on your gain. That amounts to a savings of $4590 in tax savings.
This should clear up some issues on how to treat your chart of accounts for a web-based business that deals with domains and websites frequently.