You may give it “the old college try” but fail. Not all ideas work out well. Not every effort succeeds. During this pandemic, unfortunately there are a growing number of failures. Deals fall through. Businesses go under. When you’ve invested your time and money only to come up short, what happens from a tax perspective?
If your business is incorporated and goes bust, your stock becomes worthless. You can deduct the loss in the year of worthlessness. Assuming you owned the stock for more than a year, it is a long-term capital loss. If you just started up and the stock became worthless before a year and a day, the loss is a short-term capital loss.
Special rule for Section 1244 stock. If the stock is of a small business that meets certain tests, the loss is treated as an ordinary loss, rather than a capital loss. The limit is $50,000 for singles and $100,000 for joint filers. If the amount of the loss exceeds the applicable limit, the excess loss is a capital loss.
When you start a business, you can deduct startup costs—costs incurred before you open your doors—in the first year of operation. An initial deduction is limited to $5,000. If your startup costs are greater, you amortize them over 15 years. If startup costs exceed $50,000, then all costs are amortized, with no initial deduction.
If you’ve been amortizing some startup costs but close up shop before the end of 15 years, you can deduct the unamortized costs on the tax return for your final year of business.
Note: The same holds true for organizational costs for a corporation or a partnership.
Patents and copyrights
To obtain government protection for intellectual property you create, such as patents and copyrights, can involve substantial investments. These may be high legal expenses for patents, or work-related expenses for a copyright (e.g., travel expenses to research a book). These costs were not immediately deductible but instead were capitalized and depreciated over the life of the patent or copyright. If you acquired this intellectual property as part of the purchase of a business, the cost had to amortize over 15 years. Similarly, if you had creative property costs develop screenplays, scripts, story outlines, motion picture production rights to books and plays, and other similar properties for purposes of potential future film development, production, and exploitation. You may be able to amortize creative property costs for properties not set for production within 3 years of the first capitalized transaction over a period of 15 years.
If the patent or copyright becomes worthless, you can deduct what has yet to be written off in the year of worthlessness.
Costs of acquiring a lease
A business tenant that paid to acquire a lease must amortize the cost over the term of the lease if less than 75% of the cost is attributable to the period of the lease term remaining on the date of acquisition, taking into account any renewal period if the lease is expected to be renewed. For example, if a business pays a real estate broker $3,000 to find commercial space for a 5-year lease, the cost is amortized over 5 years.
If the lease acquisition cost hasn’t been fully amortized by the time you vacate the premises, the remaining amount is deductible.
Options to buy or sell property
Say a potential buyer has made a payment to the seller for an option to buy property within a set date. If the property isn’t bought—the option expires—the buyer takes a deduction for the option’s cost.
These are just some examples of write-offs when things don’t work out as planned. If you’re closing a business, there may be other write-offs to be claimed. Be sure to work with a knowledgeable tax advisor to claim everything for which you’re eligible.