Expense or Capitalize Pre-Opening Costs

In the start up of a new business that is operationally like the current business (a restaurant opening another restaurant), all pre-opening expenses can be deducted in the year it is incurred if done as a division of the current business.  If the new business is set up as a separate LLC or S-Corp by either the current business’ shareholders or by the current business as a disregarded entity or Q-Sub, the pre-opening costs should be capitalized, and they may be amortized if an election under Section 195 is made on the original return.  However, if the costs were deducted in the year opened and no Section195 election was made, case law shows that the pre-opening costs will be capitalized and, if a Section 195 election was not made in the original return, no amortization allowed either.  Courts say that if the new business is set up as a new entity, it was set up for valid business reasons, and therefore, the entity could not be disregarded for tax purposes.  Hence, the new business was not just a part of the current business as a division but was separate for pre-opening cost capitalization purposes.  There will be no current deduction for the pre-opening cost, as well as no amortization of the capitalization of the pre-opening cost, if no election was made under Section 195.

The planning opportunity is to keep the new business as a division until everything has been set up and is operationally running.  Deduct the pre-opening costs as expenses because, for liability purposes, case law has upheld the transferring of the division into a new entity at a later date.  If the new business needs to be set up under a new entity, don’t forget to make the election under Section195 to amortize the pre-opening costs.  By utilizing this method, all need not be lost.