12.2 Organization, Start-Up, and Loan Cost Basis

12.2 Organization, Start-Up, and Loan Cost Basis

REG Blueprint Area III, Group A also tests the basis of intangible assets, including organization costs, start-up costs, and loan costs. Cost recovery of those intangibles — MACRS is the wrong tool — is developed in /study-guides/cpa-reg/cost-recovery/amortization. This section builds the basis that later amortization uses.

Three parallel Code sections use the same arithmetic. §248 covers corporate organizational expenditures (including S corporations, which are corporations). §709 covers partnership organizational expenses. §195 covers start-up expenditures of any taxpayer that is investigating or creating an active trade or business. Current law, confirmed in the Code and in Treas. Reg. §§1.248-1, 1.709-1, and 1.195-1, is:

• In the taxable year the entity begins business (or, for §195, the year the active trade or business begins), deduct the lesser of the expenditures or $5,000.
• Reduce that $5,000 dollar-for-dollar (not below zero) by the amount by which total expenditures of that class exceed $50,000. At $55,000 or more, the immediate deduction is zero.
• Amortize the remainder ratably over 180 months, beginning with the month business begins.

Those dollar figures are statutory, not inflation-indexed, so they are testable on REG. The AICPA's assumption that candidates are not tested on inflation-indexed limitations does not pull $5,000 or $50,000 off the exam. The buckets are per Code section. A new corporation can have $8,000 of §248 organizational costs and $8,000 of §195 start-up costs; each class gets its own $5,000 immediate deduction.

The taxpayer is deemed to elect amortization unless it affirmatively elects to capitalize all expenditures of that class on a timely filed original return (including extensions) for the year business begins. The election is irrevocable and applies to the entire class. Amortization does not start on the incorporation date if the corporation is formed in March and only begins business in October; the 180-month clock starts in October.

A disregarded single-member LLC has no §709 organizational-expense election of its own; the owner's pre-opening costs are tested under §195. A multi-member LLC taxed as a partnership uses §709 for organizational expenses and §195 for start-up expenses.

What qualifies — and what never amortizes

Organizational expenditures (§248(b), §709(b)(3)) are costs that (1) are incident to the creation of the entity, (2) are chargeable to capital account, and (3) would be amortizable if the entity had a limited life. Classic qualifying costs: legal fees to draft articles of incorporation, bylaws, or a partnership agreement; state filing or charter fees; accounting fees for initial entity setup; costs of the organizational meeting; and temporary-director fees.

Start-up expenditures (§195(c)) are amounts paid or incurred in connection with investigating the creation or acquisition of an active trade or business, creating that business, or conducting activity for profit before the day the active trade or business begins, of a character that would be deductible if the business were already operating. Classic qualifying costs: pre-opening advertising and market surveys, employee training before opening day, travel to secure suppliers or customers before operations, and consultant fees to design a new shop's operating system. Rev. Rul. 99-23 draws a further line: general investigatory costs to decide whether to enter a new line of business, and which business, are start-up. Once the taxpayer has decided to acquire a specific business, facilitative costs of that acquisition are capital costs of buying that business, not §195 start-up.

Syndication costs are different. §709(a) denies any deduction to the partnership or to any partner for amounts paid to promote the sale of (or to sell) an interest in the partnership. Printing the offering memorandum, brokerage commissions on units sold, and road-show costs are syndication. They are not organizational expenses, they are not start-up expenses, and they are not amortizable. The corporate analog is stock-issuance / underwriting cost: a reduction of additional paid-in capital, not an amortizable intangible.

If a partnership liquidates before the 180-month period ends, remaining unamortized organizational expenses are generally deductible under §709(b)(2) to the extent allowable as a loss under §165. Remaining start-up costs are likewise recovered when the business is disposed of. Do not wait for liquidation to recover costs that were never eligible for the 180-month schedule in the first place — syndication stays capitalized.

Loan-cost basis

Fees paid to obtain a business loan — origination fees, third-party closing costs, and similar amounts that buy the use of the money — are capitalized. They create an amortizable intangible whose recovery period is the term of the loan, generally on a straight-line basis for a fixed-term commercial loan. They are not §197 intangibles and they are not §195 start-up expenditures merely because the borrower is a new entity. If the loan is repaid or refinanced before the term ends, remaining unamortized loan-cost basis is deductible at repayment (or, on a refinance that is a continuation of the same debt, rolled into the new loan's basis).

Purchased §197 intangibles versus self-created intangibles

§197 is the acquisition rule. When a taxpayer purchases assets constituting a trade or business, amounts allocated to goodwill, going-concern value, workforce in place, information base, know-how, customer-based intangibles, supplier-based intangibles, licenses, covenants not to compete entered into in connection with the acquisition, and franchises, trademarks, or trade names become amortizable §197 intangibles. Basis is recovered ratably over 15 years (180 months) beginning with the month of acquisition, regardless of the intangible's legal life. A three-year covenant not to compete acquired in a business purchase is still a 15-year asset.

Self-created goodwill, going-concern value, and customer lists generally are not amortizable §197 intangibles. The taxpayer may have capitalized cost, but there is no 15-year deduction until a later sale or abandonment. Narrow exceptions exist for certain self-created licenses, franchises, trademarks, and trade names, and for intangibles created in connection with acquiring a trade or business; those exceptions belong in the amortization chapter. Anti-churning rules can also block §197 amortization of goodwill acquired from a related person who held it before the 1993 effective date. The exam fork in this section is simpler: purchased in an acquisition → 15-year amortizable basis; self-created going-concern → generally no §197 amortization.

Worked scenario: $8,000 of Year 1 organizational legal fees

Facts. Delta Inc., a calendar-year C corporation, is formed in January of Year 1 and begins business on January 1. It incurs $8,000 of legal and state-filing fees to draft the articles, bylaws, and organizational minutes. The fees are incident to creation and chargeable to capital. Delta spends nothing on pre-opening advertising and does not issue stock through an underwriter. Delta does not elect to capitalize organizational expenditures.

Analysis.

1. The $8,000 is a §248 organizational expenditure. Total organizational costs ($8,000) do not exceed $50,000, so the $5,000 immediate deduction is not phased out.
2. Immediate Year 1 deduction: $5,000. Remainder: $3,000, amortized over 180 months beginning in January.
3. Year 1 amortization: $3,000 × 12/180 = $200. Total Year 1 deduction: $5,200. Unamortized organizational-expenditure basis at December 31: $2,800.
4. If Delta had begun business on July 1, Year 1 amortization would be $3,000 × 6/180 = $100, and Year 1's total deduction would be $5,100.
5. If the same $8,000 had been a broker's commission to sell partnership units, none of it would be deductible or amortizable under §709.
6. If, in addition, Delta paid a bank $6,000 of origination fees on a 60-month business term loan closed on January 1, that $6,000 would be a separate loan-cost basis amortized $100 per month over 60 months ($1,200 in Year 1), not over 180 months and not as §197 goodwill.
7. If organizational costs had been $54,000, the immediate deduction would shrink to $1,000 ($5,000 − $4,000 of excess over $50,000), and $53,000 would enter the 180-month pool.

A corporation that also has start-up costs computes a separate $5,000 / $50,000 / 180-month schedule under §195. Do not dump organizational, start-up, syndication, loan, and purchased-goodwill costs into one 15-year pot.

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