9. Amortization

Introduction

Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time. It is similar to the straight line method of depreciation.

The various amortizable costs covered in this chapter are included in the list below. However, this chapter does not discuss amortization of bond premium. For information, see chapter 3 of Publication 550.

Topics

This chapter discusses:

• How to deduct amortization
• Amortizing costs of going into business
• Amortizing costs of getting a lease
• Amortizing costs of section 197 intangibles
• Amortizing reforestation costs
• Amortizing costs of pollution control facilities
• Amortizing costs of research and experimentation

Useful Items You may want to see:

Publication

• 544   Sales and Other Dispositions of Assets
• 550   Investment Income and Expenses
• 946   How To Depreciate Property

Form (and Instructions)

• 3468   Investment Credit
• 4562   Depreciation and Amortization
• 6251   Alternative Minimum Tax - Individuals

See chapter 14 for information about getting publications and forms.

How To Deduct Amortization

The purpose of this section is to explain how you deduct amortization.

Form 4562.   You deduct amortization that begins during the current year by completing Part VI of Form 4562 and attaching it to your current year's return.

For later years, do not report your deduction for amortization on Form 4562 unless you must file the form for another reason. You must file Form 4562 in any of the following situations.

• You deduct amortization that begins this year.
• You claim depreciation for property placed in service this year.
• You claim a section 179 expense deduction.
• You claim a deduction for any vehicle reported on a form other than Schedule C (Form 1040) or Schedule C-EZ (Form 1040).
• You claim depreciation on any vehicle or other listed property (regardless of when it was placed in service).
• You claim depreciation on a return for a corporation (other than an S corporation).

Other forms to use.   If you do not have to file Form 4562 for years after the year amortization begins, claim amortization directly on the Other expenses line of Schedule C or F (Form 1040) or the Other deductions line of Form 1065, Form 1120, Form 1120-A, or Form 1120-S. However, if you are amortizing reforestation costs, see Where to report under Reforestation Costs, later.

Going Into Business

When you go into business, treat all costs you incur to get your business started as capital expenses. Capital expenses are part of your basis in the business. Generally, you recover costs for particular assets through depreciation deductions. However, you generally cannot recover other costs until you sell the business or otherwise go out of business. See Capital Expenses in chapter 1 for a discussion of how to treat these costs if you do not go into business.

You can choose to amortize certain costs for setting up your business over a period of 60 months or more. The cost must qualify as one of the following.

• A business start-up cost.
• An organizational cost for a corporation.
• An organizational cost for a partnership.

Business Start-Up Costs

Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with any activity engaged in for profit and for the production of income in anticipation of the activity becoming an active trade or business.

Qualifying costs.   A start-up cost is amortizable if it meets both the following tests.

• It is a cost you could deduct if you paid or incurred it to operate an existing active trade or business (in the same field as the one you entered into).
• It is a cost you pay or incur before the day your active trade or business begins.

Start-up costs include costs for the following items.

• An analysis or survey of potential markets, products, labor supply, transportation facilities, etc.
• Advertisements for the opening of the business.
• Salaries and wages for employees who are being trained and their instructors.
• Travel and other necessary costs for securing prospective distributors, suppliers, or customers.
• Salaries and fees for executives and consultants, or for similar professional services.

Nonqualifying costs.   Start-up costs do not include deductible interest, taxes, or research and experimental costs. See Research and Experimental Costs, later.

Purchasing an active trade or business.   Amortizable start-up costs for purchasing an active trade or business include only investigative costs incurred in the course of a general search for or preliminary investigation of the business. These are the costs that help you decide whether to purchase a new business and which active business to purchase. Costs you incur in an attempt to purchase a specific business are capital expenses that you cannot amortize.

Example.   In June, you hired an accounting firm and a law firm to assist you in the potential purchase of XYZ. They researched XYZ's industry and analyzed the financial projections of XYZ. In September, the law firm prepared and submitted a letter of intent to XYZ. The letter stated that a binding commitment would result only after a purchase agreement was signed. The law firm and accounting firm continued to provide services including a review of XYZ's books and records and the preparation of a purchase agreement. In October, you signed a purchase agreement with XYZ.

The costs to investigate the business before submitting the letter of intent to XYZ are amortizable investigative costs. The costs for services after that time relate to the attempt to purchase the business and must be capitalized.

Disposition of business.   If you completely dispose of your business before the end of the amortization period, you can deduct any remaining deferred start-up costs. However, you can deduct these deferred start-up costs only to the extent they qualify as a loss from a business.

Costs of Organizing a Corporation

The costs of organizing a corporation are the direct costs of creating the corporation.

Qualifying costs.   You can amortize an organizational cost only if it meets all the following tests.

• It is for the creation of the corporation.
• It is chargeable to a capital account.
• It could be amortized over the life of the corporation if the corporation had a fixed life.
• It is incurred before the end of the first tax year in which the corporation is in business. A corporation using the cash method of accounting can amortize organizational costs incurred within the first tax year, even if it does not pay them in that year.

The following are examples of organizational costs.

• The cost of temporary directors.
• The cost of organizational meetings.
• State incorporation fees.
• The cost of accounting services for setting up the corporation.
• The cost of legal services (such as drafting the charter, bylaws, terms of the original stock certificates, and minutes of organizational meetings).

Nonqualifying costs.   The following costs are not organizational costs. They are capital expenses that you cannot amortize.

• Costs for issuing and selling stock or securities, such as commissions, professional fees, and printing costs.
• Costs associated with the transfer of assets to the corporation.

Costs of Organizing a Partnership

The costs of organizing a partnership are the direct costs of creating the partnership.

Qualifying costs.   You can amortize an organizational cost only if it meets all the following tests.

• It is for the creation of the partnership and not for starting or operating the partnership trade or business.
• It is chargeable to a capital account.
• It could be amortized over the life of the partnership if the partnership had a fixed life.
• It is incurred by the due date of the partnership return (excluding extensions) for the first tax year in which the partnership is in business. However, if the partnership uses the cash method of accounting and pays the cost after the end of its first tax year, see Cash method partnership under How To Amortize, later.
• It is for a type of item normally expected to benefit the partnership throughout its entire life.

Organizational costs include the following fees.

• Legal fees for services incident to the organization of the partnership, such as negotiation and preparation of the partnership agreement.
• Accounting fees for services incident to the organization of the partnership.
• Filing fees.

Nonqualifying costs.   The following costs cannot be amortized.

• The cost of acquiring assets for the partnership or transferring assets to the partnership.
• The cost of admitting or removing partners, other than at the time the partnership is first organized.
• The cost of making a contract concerning the operation of the partnership trade or business (including a contract between a partner and the partnership).
• The costs for issuing and marketing interests in the partnership (such as brokerage, registration, and legal fees and printing costs). These syndication fees are capital expenses that cannot be depreciated or amortized.

Liquidation of partnership.   If a partnership is liquidated before the end of the amortization period, the unamortized amount of qualifying organizational costs can be deducted in the partnership's final tax year. However, these costs can be deducted only to the extent they qualify as a loss from a business.

How To Amortize

You deduct start-up and organizational costs in equal amounts over a period of 60 months or more. You can choose a period for start-up costs that is different from the period you choose for organizational costs, as long as both are not less than 60 months. Once you choose an amortization period, you cannot change it.

To figure your deduction, divide your total start-up or organizational costs by the months in the amortization period. The result is the amount you can deduct for each month.

Cash method partnership.   A partnership using the cash method of accounting cannot deduct an organizational cost it has not paid by the end of the tax year. However, any cost the partnership could have deducted as an organizational cost in an earlier tax year (if it had been paid that year) can be deducted in the tax year of payment.

When to begin amortization.   The amortization period starts with the month you begin business operations.

How To Make the Choice

To choose to amortize start-up or organizational costs, you must attach Form 4562 and an accompanying statement (explained later) to your return for the first tax year you are in business. If you have both start-up and organizational costs, attach a separate statement to your return for each type of cost.

Generally, you must file the return by the due date (including any extensions). However, if you timely filed your return for the year without making the choice, you can still make the choice by filing an amended return within 6 months of the due date of the return (excluding extensions). For more information, see the instructions for Part VI of Form 4562.

Once you make the choice to amortize start-up or organizational costs, you cannot revoke it.

Corporations and partnerships.   If your business is organized as a corporation or partnership, only your corporation or partnership can choose to amortize its start-up or organizational costs. A shareholder or partner cannot make this choice. You, as shareholder or partner, cannot amortize any costs you incur in setting up your corporation or partnership. The corporation or partnership can amortize these costs.

You, as an individual, can choose to amortize costs you incur to investigate an interest in an existing partnership. These costs qualify as business start-up costs if you acquire the partnership interest.

Start-up costs.   If you choose to amortize your start-up costs, complete Part VI of Form 4562 and prepare a separate statement that contains the following information.

• A description of the business to which the start-up costs relate.
• A description of each start-up cost incurred.
• The month your active business began (or was acquired).
• The number of months in your amortization period (not less than 60).

Filing the statement early.   You can choose to amortize your start-up costs by filing the statement with a return for any tax year before the year your active business begins. If you file the statement early, the choice becomes effective in the month of the tax year your active business begins.

Revised statement.   You can file a revised statement to include any start-up costs not included in your original statement. However, you cannot include on the revised statement any cost you previously treated on your return as a cost other than a start-up cost. You can file the revised statement with a return filed after the return on which you chose to amortize your start-up costs.

Organizational costs.   If you choose to amortize your corporation's or partnership's organizational costs, complete Part VI of Form 4562 and prepare a separate statement that contains the following information.

• A description of each cost.
• The amount of each cost.
• The date each cost was incurred.
• The month your corporation or partnership began active business (or acquired the business).
• The number of months in your amortization period (not less than 60).

Partnerships.   The statement prepared for a cash basis partnership must also indicate the amount paid before the end of the year for each cost.

You do not need to separately list any partnership organizational cost that is less than $10. Instead, you can list the total amount of these costs with the dates the first and last costs were incurred.

After a partnership makes the choice to amortize organizational costs, it can file an amended return to include additional organizational costs not included in the partnership's original return and statement.

Getting a Lease

If you get a lease for business property, you recover the cost by amortizing it over the term of the lease. The term of the lease for amortization purposes generally includes all renewal options (and any other period for which you and the lessor reasonably expect the lease to be renewed). However, renewal periods are not included if 75% or more of the cost of getting the lease is for the term of the lease remaining on the acquisition date (not including any period for which you may choose to renew, extend, or continue the lease).

Enter your deduction in Part VI of Form 4562 if you must file that form, or on the appropriate line of your tax return.

For more information on the costs of getting a lease, see Cost of Getting a Lease in
chapter 4.

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