Starting or buying a business often requires significant spending before the business officially opens. Fortunately, the tax law allows you to deduct at least some of these costs instead of waiting until you sell the business to receive a tax benefit.
In general, you may deduct up to $5,000 in qualifying start-up expenses during your first year in business and amortize any remaining amount over 15 years. However, the rules are detailed, and the type of expense matters.
Two categories of expenses commonly qualify as deductible start-up costs:
1. Investigatory expenses incurred while exploring whether to enter a business
2. Pre-opening expenses incurred after you decide to start or acquire a specific business
Examples of deductible investigatory expenses include market studies, travel to evaluate locations, suppliers, labor availability, and fees paid to lawyers or accountants while evaluating potential business opportunities.
Once you decide to purchase a specific business, however, acquisition costs such as due diligence fees, appraisal costs, and contract negotiation expenses are capital expenses that are generally not immediately deductible. You amortize (similar to depreciation) those costs over 15 years.
You also may deduct many ordinary pre-opening costs, including advertising, website development and hosting, rent, utilities, employee training, insurance, permits, and professional fees incurred before opening.
Some expenses follow separate tax rules and do not qualify as start-up expenses. These include inventory, buildings and equipment, and research expenses as well as interest, taxes, and organizational costs for corporations or LLCs.
Timing is important. Your business officially begins for tax purposes when it starts operating as a going concern—such as when it opens to customers, starts offering services, or begins selling products. If you buy an existing business, then it officially starts the day you take ownership of it. Until then, many expenses remain subject to the start-up rules. It is important to document when the business officially become active and ready for customers or clients.
If you as an individual incur investigatory expenses merely to explore starting a new business or to purchase an existing business that you never specifically identified, the expenses are personal expenses that are not deductible.
Careful planning and record keeping can help maximize deductions and avoid costly mistakes. You also should work with a tax professional to ensure that the return accurately reflects costs that are currently deductible vs amortizable.