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Things to know when you’re leasing a commercial property
Triple net lease:
The building owner calculates the triple net cost per square foot, and the renter pays his portion based upon the number of square feet he is renting. Add the property's real estate tax and the insurance bill. Divide by the number of square feet of rental space in the building.
Examine the previous year's maintenance costs. Decide if they are reflective of the costs you will have in the next year. If not, make adjustments to the best of your ability. For instance, if gas prices have risen, you can expect the cost of snowplowing to go up. Divide maintenance costs by the number of square feet of rental space in the building.
Add the costs for maintaining common area such as hallways, restrooms and lobby. This might include carpet cleaning, bathroom supplies and utilities. Divide by the number of square feet of rental space in the building
Add the annual costs, per square foot of rental space, for taxes, insurance, building maintenance and common area maintenance. Divide by 12 for the monthly cost of expenses.
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Signing a commercial lease
What is a commercial lease?
A commercial lease is a written agreement between a landlord and a business tenant. This legally binding contract allows you, as the tenant, to use the commercial premises for your business activity for a specified period of time by promising to pay an agreed-upon rate to the landlord.
Leasing a commercial space is often a two-part process. First you sign the offer to lease. Then, after negotiations take place, you sign the lease containing the details of the negotiations.
Here are a few items to keep in mind as you investigate commercial property:
- Be ready to negotiate. You are not expected to agree to all terms immediately, so be prepared to go back and forth.
- Take the time to understand what is included in your lease. Go through it carefully on your own, then with your team of professionals (lawyer, accountant, lease consultant, property inspector, etc.).
- Always get decisions and changes in writing — a verbal agreement may not stand up in court.
- The amount of rent you pay is important, but other aspects of the lease are also significant.
- Be prepared to walk away.
Things to consider when signing a commercial lease
There is no such thing as a standard commercial lease, but there are common points covered by most leases. Commercial property leases can include the following items:
You will occupy the premises for either a fixed or renewable period of time. Your lease may be month-to-month or for a much longer term. The clause describing the term of your lease may include renewal options.
Commercial rents are usually based on the size of the space or the square footage. Your landlord may add operating costs to this base rent.
Various types of commercial leases involve different rent calculations:
Percentage rent lease — If you own a retail business, you might pay a base rent plus a percentage based on your sales.
Gross rent lease — You pay a flat rate equal to base rent plus other specific expenses. The landlord pays the other operating costs.
Net lease — You pay some of the taxes plus the base rent.
Net-net lease — You pay base rent, taxes and insurance costs to the landlord.
Triple net lease (net-net-net) — You pay base rent, taxes, and operating and maintenance costs.
Space and Services
Does your lease cover the actual square footage? It never hurts to take measurements. Which common spaces are included (washrooms, lobby, etc)?
Find out whether the following services are included:
- Parking — Is there enough for all tenants and their clients?
- Heating, ventilation and air conditioning — Is this a 24-hour service?
- Cleaning service for common spaces
- Snow removal/grass cutting/landscaping
To help keep you and your employees healthy, look for building features such as:
- Indoor stairwells that are designed for everyday use
- Standards for indoor air quality
- Smoking restrictions near: doors, building air intakes and operable windows
- Building certifications such as LEED, BOMA Best and WELL
Also, it may be useful to find a building near amenities such as:
- Public transit
- Safe and appealing walking/cycling routes
- A park or fitness options
- Healthy food options
Type of business permitted to operate on the premises
You may need written permission to use the premises for any purpose other than the original one. Find out if there are restrictions that could limit the future direction or expansion of your business.
Determine which repairs are your responsibility and which are your landlord's.
You may be allowed to make some changes or improvements and install equipment. Will these fixed assets be yours or will they become the landlord's property if you leave? Will you have to restore the property back to its original state?
Some fixtures are included in the property, such as built-in items that would damage the premises if removed. Make sure you know what you can take with you and what you will have to leave behind.
If your business expands, you might outgrow your space before the lease ends. You may need to sublet the premises, so it is a good idea to work this into a clause in your lease.
It may be okay to assign the lease to your own partners, subsidiaries or anyone with whom you merge, but you may not be allowed to sublet to anyone else outside your business without the landlord's consent.
What is covered by your landlord's insurance? You may be responsible for paying for repairs to anything not covered by this.
Will your landlord pay all property taxes? Are you responsible for any municipal taxes?
Any utilities that you must pay for, such as water, electricity, sewer, gas, phone, etc., should be listed. Your landlord may pay for anything that is not metered and then bill you accordingly.
Other items to consider
These may include details about:
- Options for first refusal if more space becomes available
- Building rules
- Damage and destruction
- What happens if the building is condemned
- Escape clause (in the event you become unable to run the business)
Because commercial leases can be complex, always enlist in the aid of experienced professionals for guidance. Before signing any commercial lease, you may wish to seek legal advice.
- Choosing and setting up a location
Trying to decide where to locate your business and how to arrange it once you get there? Consider your options.
- Store location
Know what to consider when deciding where to set up your business.
- Insurance for your small business
The right type of business insurance can provide peace of mind in both your personal and business life.
- Legal issues for small business
Do you really need a lawyer when you start your small business? Find out how legal counsel could benefit your business.
- Commercial leases
ONLY APPLIES TO : QUEBECFind out about the legal requirements governing the signature of commercial leases in Quebec.(in French only)
How to choose the right location for your business
The commercial building you choose will have a big impact on your business. Ideally, its size, layout, location and appearance should all enhance your operations while respecting zoning and environmental regulations.
Commercial buildings come in a wide variety of shapes, locations and prices, so you have to know what your needs are and how much you can afford to pay. If you've worked on a business plan, you probably know the amount you can spend on rent or a mortgage, utilities and taxes. A cash-flow analysis will help you determine whether you can afford to purchase a commercial property or if renting is your only viable option.
Renting may allow you to keep more of your working capital for business operations. Still, don't forget to take future rent increases into account. When you own your property, you know what your monthly mortgage payments will be and you are building equity for your business. Be sure to weigh out your options when deciding to buy or lease you commercial space.
It's always a good idea to seek the advice of an independent commercial real estate advisor who can help you set criteria for choosing the right building. This advisor should know the area and be familiar with zoning regulations and any potential issues concerning the building, its location or uses to which it may be put.
In the meantime, here are five tips to help guide your thinking when searching for the right location for your business.
1. Adapt your selection to the needs of your business
If you're a retailer, you probably want to make sure there's ample parking and pedestrian traffic as well as attractive decor. Situating your business close to a magnet or "anchor" store can provide you with lots of walk-by customers. If you sell high-end clothing, for example, it's probably best to avoid discount malls and instead locate your business close to other high-end retailers such as shoe stores or jewelers.
Location and decor are less important to the success of a small wholesale or manufacturing operation, but you will have to comply with zoning regulations that stipulate what types of activity are allowed where. You should also consider the availability of qualified employees within a half-hour commute of where you are considering buying.
For personal, professional or creative services, you may require a series of closed offices in pleasant surroundings with high-speed networking and easy access to public transit. The ability to attract and retain qualified employeescan be critical to success of such businesses, so a building in a central, easily accessible location can give you a strategic advantage.
When considering a loading dock, for instance, ask yourself: Is it well situated? Does it require repair? Are there more than one in the facility?
2. Does it require modification?
If you've found a suitable building in a good location, consider what it will take to make it just right. The question then becomes, "Who will pay?"
If you're renting premises that require modification, you'll have to negotiate with the owner. Make sure you have a contract specifying what needs to be done, with clear deadlines and penalties for not completing the work on time. These provisions need to be written into your lease.
If you want to buy, use an accredited inspection company to evaluate the building for defects and the entire property for environmental contamination. Defects can be points for negotiation with the seller—or signs of future headaches best avoided altogether.
Not all changes are within the power of an owner to complete. There may be zoning or heritage regulations that require renovations to be approved by a local board. Even a minor change, like inserting a shipping door into an old brick façade, can require municipal approval. This can take time, and there's no guarantee the changes requested will be allowed.
3. Consider local taxes and infrastructure
Taxes vary between municipalities, with some towns offering preferential rates in the hopes of attracting businesses. Your commercial real estate agent should know what the taxes will be, as well as the infrastructure and utilities—including Internet access, garbage pickup, roads, electricity and natural gas—that are available at the sites you're considering.
4. Allow for future growth
It's great to have room to expand. But paying for extra space that might come in handy at some time in the future might not be the best use of your working capital. Before making an investment in extra space, you should be reasonably sure you'll need it within a relatively short period of time. Your business plan and advisors can help determine what you can afford.
5. Separate your needs from your wants
It's easy to become overwhelmed with the features and options available to you. Once you've looked around and seen what's available, make a "must-have" list of the things your business truly needs. Then make a wish list of features it would be nice to have, but which are not absolutely essential.
Buildings that lack all the must-have criteria should be struck off your list, so it's best to keep the must-have list short: If it's too long, no building will ever qualify. Remaining buildings should be ranked according to how well they meet the requirements of your must-have list.
A simple scoring system can help guide your choice, with each feature rated from 1 (poor) to 10 (excellent). Each point on your list can then be weighted to reflect the relative importance of that feature. A building's reception area may rate a 9, for example, but the overall importance of a reception area to your business might rate only a 2. Multiply these numbers (9 x 2, in this case), do likewise for every feature and add up the results. After you've gone through this exercise for each building you're considering, the three or four with the highest scores should all be carefully considered before you make a final choice.
Zoning issues and their impact on your commercial space
Before purchasing or leasing commercial real estate, ensure that the property is zoned appropriately for your business’s needs. Commercial and industrial zoning restrictions can be stringent, so it’s important to know what is and isn’t permitted at the new premises.
Each province and municipality has its own rules, regulations and zoning bylaws. These bylaws govern how land may be used, where buildings and other structures can be located, and the types of buildings that are permitted and how they may be used. Municipal bylaws also cover factors such as lot sizes and dimensions, parking requirements, building heights, and setbacks (the minimum distance a building can be located from a property line).
Dan LaBossière, Assistant Vice President, Business Development at BDC, recommends hiring a lawyer to do appropriate research so you can be sure your business doesn’t run afoul of any zoning bylaws. “Choose a lawyer with commercial property experience,” he says. To determine what zoning bylaws apply to the property you want to purchase, your lawyer will go to the source: the municipal planning or zoning authority, which will provide the most up-to-date zoning bylaws for the location you are considering buying.
Depending on your planned use of the property or building, answers to the following questions will help ensure your business complies with existing bylaws.
- If you plan to change the use of the property, is that new use permitted in that location?
- Do all the changes that have been made at your new location comply with that area’s bylaws, such as building height restrictions?
- What is the permitted setback from the street? Does the building conform?
- What sizes of signs are permitted and how should signs be placed?
- Are there sufficient parking spaces and, if not, do existing bylaws allow for more parking spaces?
- Have there been any previous disputes regarding zoning at this location, such as parking issues?
When it comes to zoning for commercial property, pay close attention to the following issues.
Properties classified as heritage will have more restrictions than others. Guidelines exist regarding which character-defining elements should be preserved and which can be changed. “When you buy a heritage building, there are limitations on the alterations you can make, and improvement costs are often higher,” says LaBossière. “It can be a huge undertaking that involves a lot of back and forth with municipal authorities on what changes are permitted.”
Certificate of survey
Make sure you have an up-to-date certificate of survey. LaBossière gives the example of an entrepreneur who purchased a property and had an updated survey done when he decided to upgrade. At that point, he discovered a permit for one of the buildings on the property had never been obtained, and he was required to dismantle that building.
Changes to existing bylaws
Zoning bylaws change over time. Just because the previous occupant used a property for a specific purpose does not mean you will be permitted to do the same. While a business that was established before a zoning change took place may have obtained a variance that permitted it to continue its activities, that right may not apply to future businesses that move into that location.
If you want to purchase a property on which you plan to build, you will need to apply for a building permit and ensure your plans comply with applicable bylaws. Rules can vary greatly, depending on whether you’re building new premises, altering existing premises, changing the appearance of a building or altering its use. Before starting, check with your municipality to see what you’re allowed to do with and without a permit.
1. Have I read and understood the entire lease?
Yes, you do need to read it.
I know, it's a very long (and face it, not very interesting) document, but you do need to know what it is in it.
Check the terms. Do not assume they got it right. Make sure you check the start date, end date, rent, rent escalation and any other special terms you negotiated for. Also, be sure you know what you are obligated to do.
What is the landlord obligated to do? Can you terminate it? Make sure you know what you are getting into.
2. Have I negotiated the best deal possible?
Just because they gave you a lease, does not mean your negotiation is over. Many of the terms in the lease are still negotiable. When you're reading it, make a list of all the provisions you don't like and send it to your landlord. You may be surprised by how much they are willing to change.
3. Do I have my business structure in place?
If you want to be protected by that corporate shell, make sure it's in place first.
Be sure you have your filed Articles of Incorporation for a corporation or Articles of Organization (some states call these documents Certificates) for an LLC back from the Secretary of State before you sign.
4. Do I understand the lease terminology?
For example, most leases use the term "CAM" which stands for "Common Area Maintenance".
You should be allocated a percentage of the CAM you are responsible for based on the percentage of the building you are renting.
Be sure the percentage is based upon the size of the building and does not vary based on how much of the building is rented.
5. Have I considered asking for a CAM Stop lease?
Most leases these days are "triple net" (meaning you pay rent, plus your proportionate share of CAM and property taxes for the property).
You can ask the landlord for a CAM Stop lease, meaning that you only pay for the increase in CAM fees and property taxes above your initial lease year (frequently called the "base year").
While the landlord may increase your base rental rate, it takes a lot of the "mystery fee" out of the rent. Alternatively, ask for a cap on the CAM so it cannot increase by more than a certain negotiated percent.
6. Have I read the CAM definition?
This is probably one of the most confusing sections of the lease and you will be surprised by how much you are paying for. Check to make sure you are not paying for things that relate to the landlord's marketing efforts or legal fees associated with negotiating other leases.
Other things you may want to strike are any administration fees of more than 3%, paying for benefits for the landlord's employees, build-out costs for other lease units.
Read more about negotiating CAM terms.
7. What is my responsibility for capital expenditures?
"Capital Expenditures" when used in a commercial lease typically refer to major structural expenditures, i.e. roof, foundation, HVAC (heating, ventilation, air conditioning) and other major repairs/replacements.
What is "standard" is different from town to town and property to property, but I typically advise clients against signing any lease that shifts the burden of these repair or replacement costs to the tenant. If your landlord is requiring you pay for these costs, there are compromises.
For example, if the lease says you are responsible for HVAC repair and replacement, suggest to the landlord that he strike "replacement" and that your repair obligation is limited to a maintenance contract, maybe two times per year, and that you be responsible for all general repairs up to a certain annual maximum amount.
8. Is the lease assignable?
Check to see if the landlord has the right to terminate the lease in the event you ask for an assignment; that is, for someone else to take on the lease if you sell the business. For many businesses, your location is a big piece of its value.
If the landlord has the right to terminate the lease once you ask for an assignment, that could kill your sale. Ask the landlord to remove this provision or allow it be modified so it does not apply in the event of a sale of your business. Understand that the landlord will still want the right to reject the assignment if the new tenant is not financially acceptable.
9.Will I need a personal guarantee?
If you can get away with signing a lease with no personal guaranty, you are extremely lucky. Most landlords these days will not sign unless you personally guaranty the lease. But guarantees are negotiable.
Consider providing a guaranty for only a portion of the lease term, say half. Or negotiate for a guaranty that lasts only 6 to 12 months after you terminate rather than the remainder of the lease term.
10. Am I being realistic?
If your lease constitutes 3% of a larger property, the landlord will be much more unlikely to negotiate with you than if your space is 25% or more. To truly understand what items are important to negotiate, consider hiring a lawyer to review the document and help you with the negotiations.
Your lease may seem incredibly one-sided and burdensome, but there are some very good reasons for many of those provisions and an attorney can help you decide when to cut and run and when the risk is worth it.
1. Get your own agent.
Don't rely on the landlord's agent to negotiate the best deal for you. Having your own agent gives you someone with your best interests in mind.
Look for a good commercial real estate agent and develop a relationship. You never know when you might need that person again.
2. Be ready with your financial plan.
For more start-ups and businesses that have little or no commercial credit, you're going to need a backup plan to get the landlord to accept your terms. Providing a personal guarantee or a co-signer, and having a business income statement and personal financial statement can smooth the process and get your landlord to relax.
3. Know your essentials.
You must be able to talk the talk. While an agent can help, you should know the difference between COL (cost of living) and CAM (common area maintenance). Review this leasing terminology glossary before you begin negotiating. You may also hear such terms as "TI" or "leasehold improvements" or "build-out." Understanding the differences between terms can help you evaluate what the landlord or agent is telling you.
4. Get a good CAM section.
CAM (common area maintenance) is probably one of the most confusing sections of the lease and you will be surprised by how much you are paying for. Check to make sure you are not paying for things that relate to the landlord's marketing efforts or legal fees associated with negotiating other leases.
Other things you may want to strike are any administration fees of more than 3%, paying for benefits for the landlord's employees, build-out costs for other lease units.
5. Get only the space you need.
Make sure you aren't paying for unusable space. You may want the option to expand, but you don't want to lock yourself into paying for more space than you need. If there's a space available next to yours, put in a "right of first refusal" clause in your lease, so you have the option to first dibs on that space if it becomes available.
6. Review the lease documents.
First, review this article about common commercial lease documents, so you know what's required. Then read all the documents. Yes, you do need to read it. I know, it's a very long (and face it, not very interesting) document, but you do need to know what it is in it. Check the terms. Do not assume they got it right. Make sure you check the start date, end date, rent, rent escalation and any other special terms you negotiated for. Also, be sure you know what you are obligated to do. What is the landlord obligated to do? Can you terminate it? Make sure you know what you are getting into.
7. And be prepared to trade.
If you can take the lease for a longer term, you can get a better rate.
Consider what you can give up to get other things you need.
Finally, remember that everything is negotiable.
For More Information
The lessor is the person who is granting the lease and who has the legal obligations related to the lease contract; the landlord. Sometimes this is an owner, but it may also be a property management company or commercial leasing company.
The lessee is the person leasing the space; the tenant. Although you may need to personally guarantee a lease, your business entity should be the official lessee on all documents relating to the lease.
Common Area Maintenance (CAM)
This term describes costs for areas in a building which are not directly leased but which are a common responsibility, such as hallways, restrooms, stairways, and walkways. Most lessors add CAM costs to square footage costs to calculate lease payments.
Fully Serviced Lease
A lease in which the rental payment includes other services, such as utilities, maintenance, and lawn/snow removal services.
The landlord pays these fees and passes them on to the tenants in the lease. This can be a benefit to tenants as it saves from having to pay these additional fees, but the landlord may be charging more than actually is being paid for these services.
A lease which includes the landlord agrees to pay for all common expenses, including utilities, repairs, insurance and (occasionally) property taxes.
The cost of a gross lease is higher than for other types of leases because all of these items are included in the amount of the lease.
A lease which includes the square footage costs, CAM costs, and all other ownership expenses, including utilities, repairs, insurance, and property taxes.
Double Net Lease
A lease in which taxes and insurance expenses are included in the lease payment. The lessor pays maintenance costs.
Triple Net Lease
A lease which includes all taxes, insurance, and maintenance costs in the monthly payment.
Gross Square Foot
The total square footage of the building or office being leased. This figure usually includes common space.
An abbreviation for 'heating, ventilating, and air conditioning.' It's often pronounced as "H-VAC."
Build-out/Leasehold Improvements/Tenant Improvements
The improvements to the office or building to make it usable for the tenant. In accounting terminology, these costs are called "leasehold improvements," and they can be depreciated as expenses.
An office or building that is ready to occupy. In most cases, this is a commitment by the landlord to bear the cost of any build-out.
A sublease is an agreement between the lessor and lessee to allow someone else to use all or part of the space.
In some cases, a business may wish to have another business to share the space - and the rent. In other cases, the tenant may want to leave before the lease term is up, and to have someone else take over the lease, to avoid having to re-negotiate.
For More Information on Commercial Leasing Terms
To help you negotiate the commercial real estate lease, Lahle Wolfe, Women in Business Expert, has a list of commercial lease terms you can negotiate.
The National Association of Realtors has a comprehensive list of commercial leasing terms.
What's the difference between tenant improvements ("TI,") "leasehold improvements," and "build-out" in a commercial business lease?
Basically, no difference. It just depends on what industry you are in or who is looking at the issue. All three terms mean work that is done to an office or building to prepare it for the needs of a new tenant.
The term TI or "tenant improvements" (used by commercial realtors) can also be expressed from an accounting viewpoint as "leasehold improvements," and from a construction viewpoint as "build-out." I have heard different professions use these terms; leasing companies and property management companies and commercial Realtors talk about TI or build-out; accountants talk about leasehold improvements
For the purposes of this article, I will use the term "leasehold improvements," because that's the term used most often in business accounting, record keeping, and taxes.
Leasehold Improvements and Business Startup
TIP: Whatever someone calls it, be aware that you will need to make these changes, and pay for them, as your start your business. To keep your startup costs low, look for commercial space that doesn't need a lot of work, or find a place where the landlord will let you do a lot of the work yourself.
A young couple, Mario and Eleanora, are considering leasing an office for their chiropractic practice. It used to be the office of a massage therapist, so it probably doesn't need much work - just some paint, one wall torn out, and a little electrical work. Some offices they looked at, though, needed a lot of work: tearing down and moving walls, electrical, plumbing, HVAC (heating, ventilation, air conditioning), disability access changes, and more.
The money they pay to have the office redone to fit their needs is considered leasehold improvements.
What are Leasehold Improvements?
Leasehold Improvements (sometimes referred to as "build-outs") are the structural changes you make to leased space to make it suitable for your business needs. For example, lighting changes, a reception area, offices, dressing rooms, and other special rooms or partitions might be needed, as well as paint and carpeting/flooring.
These costs may be paid by the landlord (and included in your monthly rent) or you may be able to make some changes yourself and save money.
Accounting for Leasehold Improvements
From an accounting standpoint, the work that is done to a building and the fixtures that are put in place and attached to the property (lights and plumbing, for example) are considered assets of your business, since you pay for them. You get to depreciate them and treat them in every way like other assets; you just can't sell them unless you sell the building.
The Problem with Leasehold Improvements
Spending too much on leasehold improvements in a common mistake made by new business owners. Be wary of putting too much money into leasehold improvements for a leased business space. You can't take them with you. The next person to rent that space may not want the same things you do.
For example, if you have a retail space and add a fancy front desk for taking credit cards, the money you have spent on that front desk is not recoverable, from a cost standpoint.
I guess you could pull it out, but you can't pull out lights and wiring and bathrooms.
More Information on Leasehold Improvements
Starting a business? The bad news is that it costs a lot to pay all the costs for business startup. But the good news is that you can deduct most of these startup costs from your business tax return.
Lots of misinformation is floating around the internet about business startup costs and what you can deduct.
Some startup costs can be deducted in your first year of business, while other costs must be amortized (spread out) over several years.
It's complicated (it's the IRS, you know), but we'll straighten it out.
What are Business Startup Costs?
New businesses can deduct their costs for starting into business, but there are limits and restrictions on these costs.
The IRS says that start-up costs are "amount paid or incurred for
- Creating an active trade or business, or
- Investigating the creation or acquisition of an active trade or business."
Costs of starting a business can be separated into two time periods:
- costs for investigating and
- costs of start-up.
Business start-up costs are typically considered capital expenditures because they are for the long-term, not just the first year. That is, they are part of your investment in the business assets, and investment costs are amortized (spread out) over several years.
What is Not Included in Startup Costs?
Some expenses you might have during the startup phase of your business are not deductible as startup costs, including
- Costs to qualify to get into that type of business (getting a real estate license, for example).
Costs of buying business assets (like a building, equipment, or vehicles). These costs are considered separately for tax purposes.
When Does a Business Start?
Determining the date when your business actually starts depends on several factors, but it's important to determine a startup date for the purpose of deducting startup costs.
For example, if you are investigating the purchase of a business, you need to know how far back you can deduct these costs. Typically, you can go back one year from the startup date.
How Much Can I Deduct, How Do I Make the Deduction, and When Can I Deduct It?
If you are buying a business, the costs you have "in the course of a general search for or preliminary investigation of the business" are considered capital costs and they cannot be amortized over 15 years. Other costs may be able to deduct immediately.
Choices in Deducting or Amortizing Start-up Costs
You may deduct up to $5,000 in start-up costs in your first year in business. This deduction is restricted if you have over $50,000 in start-up costs. If you have additional start-up costs over the $5,000, you can amortize these costs over 15 years. If you are not going to be profitable in your first year, you may want to consider another option to minimize your taxes in years where you make more profit.
Instead of deducting $5,000 in your first year, you may amortize all start-up costs over 15 years, taking the same deduction each year. For example, if your start-up costs are $45,000, you could deduct $3,000 a year for 15 years.
You can also wait to recover your start-up costs until you sell your business or close the business, but most business owners don't want to wait that long to get the tax benefit from these start-up costs.
Bonus Deduction for Organizational Expenses
The IRS separates general business startup costs and organizational costs. Organizational costs are those costs involved in forming a corporation, partnership, or limited liability company (not a sole proprietorship). These costs must be incurred before the end of the first tax year the company is in business.
In addition to the $5,000 start-up deduction, you can take up to $5,000 in additional deduction for small business organizational expenses, up to $50,000. The deduction would be applied to legal fees and other expenses for forming your business structure.
Business Startup Cost Deductions: An Example
Let's say you have started an LLC in 2017. You have $8,000 in deductible startup costs and $2,000 in costs to set up the LLC. Here's how the deduction might work:
- You can deduct the $2,000 in LLC setup costs on your 2017 business tax return, as organizational expenses.
- You can also deduct $5,000 of your other startup costs on your 2017 taxes.
- The other $3,000 in startup costs must be amortized over the following few years, as required by the IRS.
Note that this assumes all of the costs are legitimate deductions. Your job is to collect the costs and let your tax professional tell you if they are legitimate and how they can be deducted.
What If I Don't Go Into Business? Can I Still Deduct These Expenses?
If you are investigating a specific business to start or buy, and the deal doesn't work, you can deduct your personal expenses on Schedule A of your Form 1040 as "miscellaneous expenses."
If you are searching for a business but have no specific business in mind, and you decide not to buy any business, you cannot deduct these expenses; they are not related to any specific business.
A Startup Costs Worksheet
To help you put all your startup costs in one place, and make sure you don't miss any costs, here's an article showing you how to create a startup costs worksheet.
A Disclaimer: As you can see, attempting to deduct business startup costs is complicated, and the tax laws change frequently. You will need to check with your tax professional before attempting this deduction.