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Investigating the potential for a new business and getting it started can be an expensive proposition. However, under the general rules for business deductions you couldn't deduct these expenses, because only expenses for an existing trade or business can be deducted. By definition, you incur your startup expenses prior to the time that your business is born.
Fortunately, there are two relief provisions that allow you to obtain a tax benefit from some, or all, of your startup expenses:
However, the $5,000 current deduction limited by two rules. First, the maximum $5,000 or your actual costs--whichever amount is lower. In addition, the $5,000 maximum is reduced dollar-for-dollar by the amount that the startup expenses exceed $50,000.
What costs qualify? Only those costs that would be deductible if they were incurred by an existing trade or business are eligible for the election. Investigation expenses that can be deducted over the 180-month period include those relating both to business conditions generally, and those relating to a specific business, such as market or product research to determine the feasibility of starting a certain type of business. The costs of checking out the various factors involved in site selection would also be an amortizable investigation expense.
Amortizable costs of creating a business include advertising, wages and salaries, professional and consultant fees, and costs of travel before the business actually begins.
What costs don't qualify? Although they are frequently incurred before a new business goes into operation, the following costs don't qualify for 180-month amortization:
What if you don't start the business? If you ultimately decide not to go into business, what happens to your costs? The portion of costs you paid to generally investigate the possibilities of going into business at all, or to purchase a non-specific existing business, are considered personal costs and are not deductible.
However, the total costs that you paid in your attempt to start or purchase a specific business would be considered a capital expense and you can claim it as a capital loss.
If you purchased any business assets along the way (for instance, some bagel-making machinery), you can claim a loss only if and when you sell or dispose of the property.
Claiming business start-up expenses. Assuming your business was successfully launched and you want to amortize your startup costs, total up all the costs paid or incurred before your business opened. Once you have this total, you need to determine how much of the expenses can be deducted in the current year.
For the first year, your amortization deduction would be shown on Part VI of Form 4562, Depreciation and Amortization, and then carried over to the appropriate tax form for your business. For sole proprietors, it would be carried over to your Schedule C as an "other" expense.
In later years, if you are filing Form 4562 for some other reason (generally you must file this form in the first year you put a capital asset into service), you would continue to show your amortization costs on Part VI and on your Schedule C. If you don't need to file the 4562 in a particular year, simply list your amortization amount as an "other" expense on your Schedule C (or your partnership or corporate income tax form).