Many business owners know their business-related expenses may be deductible, but there are different tax rules for business start-up or acquisition costs. Investigatory costs, start-up costs, organization costs, capitalized costs and expansion costs are treated by the IRS as follows:
- Section §195, Investigatory Expenses: These are startup costs to investigate the potential for creating or acquiring an active business, such as analysis of markets, surveys, labor supply, etc. No final decision has been made whether to acquire or create an operating business. These expenses, otherwise deductible under section 162 as ordinary and necessary, are subject to §195 due to the fact that there is not yet an operating business. When there is an operating business, these expenses must be amortized over 15 years (with a $5,000 immediate write off allowed if the total expenses are under $50,000).
- Section §195 Pre-Opening Start-up Costs: A business has now been identified and acquired. These expenses are pre-opening business expenses that would otherwise be deductible, such as advertising, training, rent, utilities, etc. The expenses are amortizable over 15 years.
- Section §197 Intangibles – Start-up/Acquisition Costs: Once a specific business has been identified (a “Target”), any costs incurred prior to the business becoming active and operating, are to be capitalized as §197 Intangibles. These costs could include goodwill, patents, licenses, covenants, etc. The write-off period for these costs is 15 years.
- Section §248, Organizational Costs: These are costs incurred to form a partnership or corporate entity. They are not currently deductible, but instead must be capitalizable with write-off/expense limitations the same as §195 above.
- Section §263, Capitalized Costs: Long-lived assets must be capitalized as acquisition costs and, depending on the asset, may in some cases be depreciated/amortized after the business begins operations. These expenses could include costs to acquire a capital asset: appraisal fees, legal fees, brokerage fees, etc. The “due diligence” costs incurred by a buyer, once a Target has been identified and a letter of intent submitted, are capitalizable under §263.
- Section §162 Expansion Cost: An existing business that incurs start-up costs for a new operation can deduct these costs as they are incurred as a ordinary and necessary business expense. However, if the existing business creates a new entity, these start-up costs must be capitalized and amortized under §195 for 15 years.
In summary, expenses incurred to determine whether to buy a business are investigatory costs and are amortizable under §195, while expenditures incurred to acquire a specific business are acquisition costs under §263. If you’d like more information about if your business expenses may be deductible, contact a ShindelRock tax professional .