Analysis of Computer Rental and Lease Costs (EZ Specific) in the Context of the Colorado R&D Tax Credit

I. Executive Summary: The Definition of EZ Computer Rental Costs

Qualified Computer Rental/Lease Costs (EZ Specific) are expenditures paid for the temporary right to use computing equipment or infrastructure, such as high-performance servers or cloud capacity, that are directly consumed in carrying out qualified research activities exclusively within a designated Colorado Enterprise Zone (EZ).1 These costs are critical Qualified Research Expenditures (QREs) used to calculate the 3% incremental state income tax credit, subject to rigorous geographic allocation and mandatory annual pre-certification requirements.1

Key Requirements and EZ Prerequisites

The Colorado Research and Development (R&D) Tax Credit (codified under C.R.S. §39-30-105.5) explicitly recognizes “Computer Rentals” as an allowable category of Qualified Research Expenditure.1 Unlike many state tax credits, eligibility for the Colorado R&D credit is strictly confined to expenditures for research activities that occur within one of Colorado’s designated Enterprise Zones.1 Furthermore, these computer-related costs must be treated as expenses for tax purposes, aligning with the standards set forth in Federal Internal Revenue Code (IRC) §174; depreciable assets or capitalized purchases are specifically excluded from QRE calculation.3 The credit itself is calculated using a regular incremental method, meaning the benefit is based on the current year’s QREs exceeding the average QREs from the preceding two tax years. Once calculated, the total credit is subject to an annual utilization cap, allowing taxpayers to claim no more than 25% of the total generated credit in the current tax year, with the remainder carried forward.1 A foundational compliance gateway is the mandatory annual pre-certification process with the local Enterprise Zone Administrator, which must be completed before any credit can be claimed.2

II. Statutory and Regulatory Framework of the EZ R&D Credit

2.1 Legislative Intent and Program Scope

The foundation of the Colorado R&D Tax Credit lies within the Enterprise Zone (EZ) Program, which the Colorado legislature established to stimulate economic activity in 16 designated economically distressed areas.4 These zones typically exhibit high unemployment rates, low per capita income, or slow population growth.4 By offering state income tax credits, such as the R&D credit, the state incentivizes businesses to locate, expand, and invest in these specific regions.7

A paramount requirement for claiming the R&D credit is that the research activities must be physically conducted within the Enterprise Zone.1 The Office of Economic Development and International Trade (OEDIT) guidance imposes a significant stability condition: a company must maintain its presence in the same enterprise zone for three years to claim the R&D credit.4 If a company moves to a different enterprise zone, the three-year qualification window starts over, and the company cannot claim the credit until the new three-year period is met.4 This administrative requirement implies a high degree of commitment for capital expenditure decisions. For instance, establishing or renewing long-term computer rental contracts or engaging in dedicated data center agreements must be viewed through the lens of this three-year commitment, ensuring that the business presence and associated QREs outlast the typical technology lifecycle and secure the full, multi-year benefit of the credit.

2.2 Statutory Basis: C.R.S. §39-30-105.5

The legal framework for the credit is established in C.R.S. §39-30-105.5. This statute ties the definition of “expenditures in research and experimental activities” directly to Section 174 of the Federal Internal Revenue Code.9 This federal linkage means that to qualify for the state credit, the expenditures must meet the four-part test for qualified research activities used at the federal level: the purpose must be to create a new product or update a current one, the activity must eliminate technological uncertainty, it must constitute a process of experimentation, and it must be technological in nature, relying on hard sciences or engineering.11

The Incremental Calculation and Utilization

The Colorado R&D credit is non-refundable and calculated as 3% of the increase in QREs attributable to the Enterprise Zone.2 The calculation uses a regular incremental method based solely on zone-specific QREs.1

The process follows this general methodology:

• The base amount is determined by calculating the average of the total EZ QREs from the preceding two tax years.1
• If the business had no research and experimental expenditures in one or both of the previous two income tax years within the area comprising the EZ, zero is used for that year(s) in calculating the average base.1
• The excess amount is the current year’s EZ QREs minus the base amount.1 The final credit is 3% of this positive excess.2

A unique characteristic of the Colorado credit is its limited utilization in the year it is generated. Taxpayers may claim no more than 25% of the total calculated credit in the current tax year.1 The balance of the credit, as well as any applicable carryforward amount, may be claimed in subsequent years.9 Any excess credit that cannot be used due to this annual limit or due to insufficient tax liability is carried forward indefinitely until the total amount is utilized, providing substantial long-term value, especially for innovative startups in the Enterprise Zones that may have fluctuating profitability.4

III. Defining Qualified Computer Rental and Lease Costs (QREs)

3.1 Inclusion of Computer Rentals as a Qualified Expense

The Colorado R&D tax credit guidelines specifically identify “Computer Rentals” as an eligible expense, confirming that costs incurred for the use of computers or equipment directly utilized in qualified research activities are legitimate QREs.1 This category of expenditure is derived from the federal IRC §41(b)(2)(A)(iii), which allows amounts paid or incurred to another person for the right to use computers in the conduct of qualified research.

3.2 Distinguishing Rental/Lease from Capitalized Assets

A key distinction in defining a qualified expense is the tax treatment of the asset. For computer rental costs to qualify, they must be treated as expensed, operating costs under IRC §174, not capitalized investments subject to depreciation.3 Depreciable equipment, land, or improvements to land are explicitly excluded from the definition of QREs.4

This differentiation is critical during tax compliance and subsequent audits. Lease payments that constitute genuine rentals—granting temporary usage rights—are eligible. Conversely, payments made under capital leases, installment purchase agreements, or similar financing structures that lead to the capitalization and depreciation of the underlying equipment (e.g., under MACRS) are ineligible.4 This focus on immediate expensing rewards companies utilizing flexible, short-term arrangements rather than major capital outlays for their R&D infrastructure.

3.3 Modern Application: Cloud Computing and IaaS Costs

The evolution of technology presents challenges in applying decades-old tax law. Today, much research relies on cloud computing services (Infrastructure as a Service (IaaS) and Platform as a Service (PaaS)) for tasks such as modeling, simulation, and algorithm training.14 The federal regulation (Treasury Reg. 1.41-2(b)(4)) was originally designed for mainframe rentals and mandates three criteria: the computer must be (1) owned and operated by someone other than the taxpayer, (2) located off the taxpayer’s premises, and (3) the taxpayer must not be the primary user of the specific computer.14

For typical public cloud usage (e.g., AWS or Azure), the expense is often characterized as a defensible rental cost because the infrastructure is owned by the provider, is off-premises, and the taxpayer’s workload dynamically routes across shared servers, thus avoiding the “primary user” designation.14 This allows modern cloud expenses directly related to R&D to be claimed as equivalent to “renting computers”.15

However, the geographic constraint of the Colorado EZ program introduces a layer of complexity for cloud-based claims. Because cloud servers are remote, the taxpayer must establish a direct link between the intangible cloud usage and the physical location within the EZ. This necessitates proving, through meticulous labor tracking and technical documentation, that the R&D personnel physically located within the EZ were the ones who conducted the qualified research activities that consumed the compute resources. Therefore, the claimable portion of the cloud cost must be prorated back to the EZ labor that generated the utilization, creating a necessary nexus between IT utilization data and employee time-tracking data for compliance.

Exclusions from this category include general business software subscriptions (SaaS) or professional services that do not grant the right to use the computer itself, as these expenses do not directly support the qualified research activity.15

Table 1 provides a detailed classification of computer-related expenditures:

Table 1: Classification of Computer-Related Expenses for Colorado EZ R&D Credit

IV. Colorado-Specific Proration and Allocation Requirements

4.1 The EZ Specificity Rule

The foundation of the Colorado R&D tax credit is its localization: all claimed expenditures must be for research and experimental activities conducted exclusively in an enterprise zone.9 This locational requirement imposes a strict burden on taxpayers to develop and maintain a precise methodology for segregating eligible in-zone QREs from all other expenses.1 This isolation ensures that the tax incentive only supports activities that fulfill the EZ Program’s mission of encouraging development in economically distressed areas.

4.2 Dual-Use Allocation Methodology for Shared Assets

In many business environments, rented computer assets, particularly shared cloud resources, may support both qualified research activities (QRAs) and non-research activities (e.g., general administration, marketing) or may support research conducted both inside and outside the Enterprise Zone.

To accurately determine the claimable amount, taxpayers must employ an auditable and reasonable dual-use allocation methodology. This process involves a two-step proration:

1. R&D Utilization: The taxpayer must first quantify the percentage of the rented computer time or capacity that was dedicated to performing qualified research activities (i.e., activities meeting the four-part test).
2. EZ Location: Of that calculated QRA time, the taxpayer must then determine what percentage was performed or directed by personnel physically operating within the boundary of the certified Enterprise Zone.

For highly specialized computer rental costs, such as high-performance cloud compute, detailed records must substantiate the allocation. This includes technical utilization reports, clock-hour logs, and internal project documentation cross-referenced with payroll records that confirm the EZ location of the researchers.11 Failure to isolate and document the in-zone QRA portion exposes the entire claim to risk during a Colorado Department of Revenue (CDOR) audit.

4.3 Proration for Tax Year Duration

If a business begins operations within an Enterprise Zone mid-year, the current year’s QREs are not automatically calculated for the full year. Instead, the current QREs must be prorated based on the number of full calendar months the business operated in the zone during that tax year.4 This requirement ensures the benefit is only proportional to the business’s commitment within the EZ during the current claiming period.

For example, if a company incurs $120,000 in qualifying computer rental QREs over a full 12-month tax year, but only established its EZ location and began operations in October (resulting in 3 full calendar months of operation: October, November, December), the eligible current year QREs would be limited to $30,000 ($120,000 $\times$ 3/12). It is important to note that while the current year QREs are prorated for partial operation, the calculation of the prior two-year base still requires identifying the total expenditures made in the area that comprised the EZ during those preceding tax years.1

V. Colorado Department of Revenue (CDOR) and OEDIT Administrative Guidance

Administrative compliance is as critical as the technical qualification of expenditures. The credit process is managed jointly by the Colorado Office of Economic Development and International Trade (OEDIT), which certifies the Enterprise Zone activity, and the Department of Revenue (CDOR), which processes the final tax credit claim.

5.1 Mandatory Pre-Certification and Certification Process

The administrative prerequisite for claiming the EZ R&D credit is annual pre-certification. Taxpayers must annually pre-certify their eligibility with the local EZ Administrator.2 This process is now largely conducted electronically via the OEDIT application portal.4 Precertification is effective only from the date approved until the close of the tax year indicated in the application.5

A key stricture of this administrative process is that any credit not precertified cannot be claimed on a tax return.5 This establishes pre-certification as a non-negotiable gateway; subsequent research expenses, including computer rental QREs, are retroactively eligible only if this initial administrative step was completed. After the tax year ends, the pre-certified taxpayer must complete a final certification application (form DR 0077 or its electronic equivalent) and receive approval from the EZ Administrator, which generates the required EZ Tax Credit Certificate.2

5.2 Claiming the Credit: Required Forms

To formally claim the credit against Colorado income tax liability, the taxpayer must submit the EZ Tax Credit Certificate obtained from OEDIT along with the appropriate state income tax return.4

The mandatory form used for non-refundable EZ credits is Form DR 1366, the Certified Economic Development Credit Schedule.18 This schedule is necessary to accurately calculate the available credit amount, determine the 25% annual utilization limit, and track carryforward balances.19

For pass-through entities (PTEs) such as partnerships, LLCs, and S-corporations, an additional step is required. These entities must also complete and submit Form DR 0078a for the distribution of credits, ensuring the R&D credit is accurately allocated pro-rata to individual partners, shareholders, or members.1 The Department of Revenue requires accurate identification (name and ID number) and allocation amounts on this form. Failure to accurately provide this necessary information results in the credit being denied until the information is corrected with the EZ Administrator.5

The Department of Revenue strongly recommends that all taxpayers claiming EZ credits file electronically, submitting Form DR 1366 and all supporting documentation, including the EZ Tax Credit Certificates, through their electronic systems to ensure accurate and timely processing.19

5.3 Carryforward and Utilization Rules

The structure of the Colorado EZ R&D credit provides significant long-term certainty for businesses. As mandated by C.R.S. §39-30-105.5, the total calculated credit must be divided evenly over four years, limiting the claimable amount to 25% annually.1 This ensures that the benefits of the credit are spread out, providing consistent relief.

A crucial benefit is the treatment of unused credit balances. If the credit amount allowed in any one taxable year exceeds the taxpayer’s income tax liability, the excess amount is not refundable but can be carried forward.1 The Colorado statute establishes that there is no limit on the number of years the unused credit may be carried forward, offering an indefinite carryforward provision.4 This feature maximizes the credit’s value, guaranteeing that companies ultimately realize the full benefit of their R&D investments in the Enterprise Zone, regardless of annual fluctuations in profitability.

VI. Financial Modeling and Practical Example

The effectiveness of claiming computer rental QREs is directly related to the incremental calculation method used by Colorado, which rewards current-year investment growth over the two-year historical average.

6.1 Example Setup: R&D Firm X

Consider TechCo Innovations, a software development firm located in a Colorado Enterprise Zone that utilizes high-performance cloud computing services classified as computer rentals. The company ensures all research activities meet the four-part test and are conducted entirely within the EZ.

In this scenario, TechCo significantly increased its investment in cloud computing for R&D in Year T, resulting in a substantial increase in QREs compared to the historical average.

6.2 Step-by-Step Credit Calculation

The increase in computer rental costs directly impacts the calculation of the incremental credit, as detailed below:

Table 2: Incremental Credit Calculation Based on EZ Computer Rental Increases

In this example, the $70,000 increase in computer rental QREs from T-1 to T was a primary driver in generating the total $3,750 credit, with $937.50 claimed immediately and the substantial remainder available for future use indefinitely.

VII. Conclusion and Expert Recommendations for Compliance

The Colorado Enterprise Zone R&D Tax Credit offers a valuable incentive for businesses investing in technological innovation within distressed areas. Maximizing the benefit derived from computer rental and lease costs requires strict adherence to both federal QRE standards and unique Colorado administrative and geographic constraints.

Documentation Best Practices for Computer Rental Costs

Auditable claims for computer rental QREs necessitate meticulous record-keeping to address the definition of a QRE (activity) and the Colorado EZ requirement (location and proration) simultaneously.

1. Contractual Clarity: Documentation must clearly delineate the financial structure of the asset use, confirming that the arrangement constitutes a rental or operating lease where the payments are expensed, thereby excluding capitalized assets subject to depreciation.4
2. Usage and Allocation Logs: For shared infrastructure, such as cloud services or specialized servers, detailed usage logs, tickets, or internal utilization reports must be maintained. This data is essential for isolating the percentage of use dedicated to qualified research activities.
3. Geographic Verification: The taxpayer must establish a verifiable nexus between the expense and the Enterprise Zone. For cloud services, this requires tying the utilized compute time directly back to the labor hours of the R&D personnel physically conducting the research within the certified EZ boundary. This proves the activity was “conducted in an enterprise zone” as required by statute.9
4. Project Nexus: All claims, including those for computer rental QREs, must be linked to project documentation that proves the four-part test was met—demonstrating the effort to resolve technical uncertainty through a process of experimentation.11

Critical Compliance Checklist for EZ R&D Credit

Strategic compliance planning should focus on the administrative sequence required by OEDIT and CDOR.

Table 3: EZ R&D Tax Credit Critical Compliance Checklist

By integrating the strict expensing requirements for computer rental costs with Colorado’s location-specific incremental calculation method and mandatory administrative certifications, businesses operating within Enterprise Zones can effectively leverage this incentive to offset state tax liability and support long-term R&D investment. The indefinite carryforward provision provides a substantial tax planning advantage, rewarding strategic increases in QREs like modern cloud computing rentals.

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/