According to IRS Publication 535, Business Expenses, the cost of
investigating the purchase of an existing business can be amortized as
a start-up expense. However, the purchase itself is neither amortizable
To understand why this is so, consider first of all that the IRS requires
three conditions of any depreciable property.
In order for a taxpayer to be allowed a depreciation deduction for
a property, the property must meet all the following requirements:
* The taxpayer must own the property. Taxpayers may
also depreciate any capital improvements for property
the taxpayer leases.
* A taxpayer must use the property in business or in an
income-producing activity. If a taxpayer uses a property
for business and for personal purposes, the taxpayer can
only deduct depreciation based only on the business use
of that property.
* The property must have a determinable useful life of
more than one year.
Internal Revenue Service: A Brief Overview of Depreciation
The difficulty is with the last condition, since Company B in your
scenario, or any company in general, does not have a determinable
The following informal explanation gives examples of how an asset can
have a determinable useful life.
In general, property that you own can be depreciated if it meets
all of the following requirements:
* It is used in a trade or business (which will be the focus
of our discussion here) or held for the production of income
as an investment property.
* It has a finite period of usefulness in your business
that can be estimated with some confidence, and that is
longer than one year.
* It wears out, decays, gets used up, becomes obsolete,
or loses value from natural causes.
Some business assets are not depreciable, but the costs can be
recovered through amortization; that is, they can be deducted in
a series of equal amounts over time for a specified period. An
example of this is the cost of starting your business, which
can be deducted over a period of 60 months after the business
begins to operate.
Tax Guide: Which Assets Can Be Depreciated?
Because companies do not have a finite period of usefulness that can
be confidently estimated, and because they do not naturally wear out or
degrade, they cannot be claimed as depreciable property.
However, certain expenses involved in starting up a business do qualify
for amortization, which is similar to depreciation.
Investigation expenses that can be deducted over the 60-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.
Tax Guide: Business Startup Expenses
In Chapter 9 of Publication 535, Business Expenses, the IRS draws a clear
distinction between the cost of investigating a purchase and the cost of
making the purchase. The former is amortizable, while the latter is not.
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.
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
Internal Revenue Service: Publication 535: Chapter 9
Thus, the cost to Company A of investigating the purchase of Company
B can be amortized over five years. However, the cost of the purchase
itself is not amortizable, nor is it depreciable.
irs depreciation rule
irs amortize business expense
amortize business start-up cost