40.11 Deducting Expenses of Looking for a New Business
When you are planning to invest in a business, you may incur preliminary expenses for traveling to look at the property and for legal or accounting advice. Expenses incurred during a general search or preliminary investigation of a business are not deductible, including expenses related to the decision whether or not to enter a transaction. However, when you go beyond a general search and actually go into business, you may elect to deduct or amortize your start-up costs.
Deductible or amortizable start-up costs.
If you began your business in 2012, up to $5,000 of eligible start-up expenses is allowed. The limit is reduced by the amount of start-up costs exceeding $50,000. Start-up costs over the first-year deduction limit may be amortized over 15 years. An election to amortize is made by claiming the deduction on Form 4562, and it is then entered in Part V (“Other Expenses”) of Schedule C.
Eligible costs include investigating and setting up the business, such as expenses of surveying potential markets, products, labor supply, and transportation facilities; travel and other expenses incurred in lining up prospective distributors, suppliers, or customers; salaries or fees paid to consultants or attorneys, and fees for similar professional services. The business may be one you acquire from someone else or a new business you create.
Organizational costs for a partnership or corporation.
Costs incident to the creation of a partnership or corporation are also deductible or amortizable under the rules for start-up costs discussed above. For a partnership, qualifying expenses include legal fees for negotiating and preparing a partnership agreement, and management, consulting, or accounting fees in setting up the partnership. No deduction or amortization is allowed for syndication costs of issuing and marketing partnership interests such as brokerage and registration fees, fees of an underwriter, and costs of preparing a prospectus.
For a corporation, qualifying expenses include the cost of organizational meetings, incorporation fees, and accounting and legal fees for drafting corporate documents. Costs of selling stock or securities, such as commissions, do not qualify.
An election to amortize is made on Part VI of Form 4562 for the first year the partnership or corporation is in business. The election on Form 4562 and the required statement must be filed no later than the return due date, including extensions, for the year in which the business begins.
Nonqualifying expenses.
Deductible and amortizable expenses are restricted to expenses incurred in investigating the acquisition or creation of an active business, and setting up such an active business. They do not include taxes or interest. Research and experimental costs are not start-up costs, but are separately deductible or amortizable; see IRS Publication 535 and Code Section 174. For rental activities to qualify as an active business, there must be significant furnishing of services incident to the rentals. For example, the operation of an apartment complex, an office building, or a shopping center would generally be considered an active business.
If you do not elect to deduct or amortize qualifying start-up costs, you treat the expenses as follows:
- Costs connected with the acquisition of capital assets are capitalized and depreciated; and
- Costs related to assets with unlimited or indeterminable useful lives are recovered only on the future sale or liquidation of the business.
Caution
If the acquisition fails.
Where you have gone beyond a general search and have focused on the acquisition of a particular business, but the acquisition falls through, you may deduct the expenses as a capital loss.
Job-hunting costs.
You may deduct the expenses of looking for a new job under certain circumstances (19.7).