The idea of a club at Crystal Palace was first proposed in 1904 by The Crystal Palace Company. The proposal was rejected by the Football Association, who disliked the idea of the owners of the Cup Final venue also possessing a football club. However a separate company was formed the following year in order to establish the club under the chairmanship of Sydney Bourne, chosen due to his propensity in buying tickets to the Cup Final. Crystal Palace Football Club was formed on 10 September 1905 playing in the Aston Villa colours of claret and blue. The choice of colours was a result of the important role in the club's formation played by Edmund Goodman, an Aston Villa employee who was recommended to the fledgling club by the Villa chairman. Goodman organised the business side of the club and managed the team from 1907 to 1925. A former amateur player with Villa, Goodman had lost his right leg after an injury led to amputation.
Along with two other newly formed London clubs, Chelsea and Clapton Orient, Palace applied to join the Second Division of the Football League. Chelsea and Clapton Orient were accepted, but Crystal Palace were not. Unfortunately Palace were too late to be considered for the First Division of the Southern League and were forced to settle for a place in the Second Division. To increase the number of club fixtures, they also joined the United Counties League. Manager John Robson established a team of 16 professionals, mainly drawn from Middlesbrough, and supplemented with local amateurs. The club's inaugural campaign in Division Two of the Southern League, which consisted mainly of other clubs' reserve sides alongside Southall, Southern United, St. Leonard's and Grays United was a successful one. Their opening match was against Southampton Reserves, and approximately 3,000 people paid 6d to stand or a shilling to sit. Palace led 3–0 after 30 minutes, before fading and losing 3–4. However, that was the club's only defeat in the League all season, and Crystal Palace won the championship and were promoted to the Southern League First Division. The season included a run of 17 straight victories, and a 9–1 win over Grays United at Crystal Palace. Attendances for the season were regularly between 2,000 and 3,000 although 4,000 watched the 1-1 FA Cup tie against Blackpool. Palace also secured their record victory in this season, a friendly against West Beckenham on the 24 February 1906 which Palace won 17–2.
As a brand new club Crystal Palace had to qualify for entry into the first round proper of the FA Cup. In the first qualifying round Palace were drawn at home against Clapham. The match saw Palace run out 7-0 winners, with William Watkins scoring the first ever hat-trick. The next round saw Palace overcome the 2nd Grenadier Guards and earn a draw against Chelsea in the third qualifying round. Chelsea at the time were a big draw, fielding the famous goalkeeper, William Foulke. Sadly, Chelsea were obliged to fulfil a League fixture on the same day, and chasing promotion from the Football League Second Division, decided to concentrate on the league. They fielded a reserve side against Palace who duly ran out 7-1, with Watkins scoring another hat-trick. The ease of this victory saw the FA change the rules to ensure clubs always fielded their strongest sides. Palace then dispatched Luton Town in the fourth and final qualifying round to ensure a place in the First Round Draw. Here they were paired with Blackpool, and the tie was eventually settled in a second replay at neutral venue Villa Park after both teams failed to make home advantage pay.