How to Write Off Start-Up Costs

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Some businesses, such as consultants, may be able to get up and running on a wing and a prayer. More typically, it costs money to get things set up right before the doors open for business. The average cost of starting a restaurant is nearly half a million dollars (without purchasing land). Start-up costs mean you’re laying out funds before any revenue starts to come in.

The Problem

Ordinary and necessary business expenses generally are deductible by your business. But what about expenses you have before you open your doors? You’re not yet in business, so there’s no business to deduct them. However, certain costs associated with starting a business can be deductible, either in the first year of business or over time. These are called start-up costs in tax law and the same deduction rules apply whether the business is a sole proprietorship, partnership, or corporation.

What Are Start-up Costs?

These are costs that normally would be deductible if you’d been operating at the time you paid or incurred them. These do not include the cost of purchasing a business or franchise, or other capital costs, even though your start-up capital may be used to cover the purchase price.

There are three categories of deductible start-up costs:

• Investigatory expenses made to decide whether to go into business and which business to buy or start. Costs in this category include surveys and analysis of potential markets, products, and labor, as well as travel costs to look at businesses or business sites.
• Business start-up costs after deciding to go forward but before the business begins to operate. These include advertising, training employees, traveling to line up vendors, distributors and customers, consulting fees, and fees to set up accounting books.
• Pre-opening costs are any other costs paid or incurred before the day that the business starts.

Again, not all costs associated with starting a business fall into these categories. Costs that normally must be capitalized in addition to the purchase price of a business, such as legal fees to buy property, are not immediately deductible. Instead, they become part of the cost basis of that property. Costs for building out a store or restaurant are also not deductible as start-up costs (although there may be other write-offs available).

How Much Can You Deduct?

Start-up costs paid or incurred after October 22, 2004, can be deducted up to $5,000 this year if the business starts in 2011. If costs exceed $5,000, that dollar limit is reduced by one dollar for each excess cost. Once expenses exceed $55,000, no immediate deduction is allowed.

Expenses that cannot be immediately deducted can be claimed over a period of 180 months. For example, if a business opened its doors on January 1, 2011, and had $60,000 in start-up costs, no immediate deduction could be claimed. However, $4,000 ($60,000 ÷ 180 x 12) is deductible in 2011.

Bottom Line

If you’re thinking of starting a business, keep good records on what you’re spending money on, such as travel to see potential vendors and lunches you take them to. Save receipts and keep good notes about what the expenditures are for. Then you’ll be able to maximize the write-off for your start-up costs.

The tax law treats you as automatically electing to deduct start-up costs if you’re eligible to do so; no special election is required. But you can opt not to deduct them immediately and instead amortize them over the 180 months, or merely capitalize them (add them to basis). Newly issued final regulations explain how to make this election. It’s best to work with a tax advisor to make sure you get all the write-offs you’re entitled to.