Important Note for Start-Ups

May 26, 2009 | Subscribe to our RSS Feed

The tax court recently handed down an unfavorable decision to a taxpayer claiming deductible expenses for his start-up business (real estate investing).

Background

Qualifying deductible business expenses must be directly connected with or pertain to the taxpayer’s trade or business (Code Sec. 162), and the enterprise must be functioning as a business when the expenses are incurred. Until the business is functioning, start-up expenses may be deductible under a different section of the tax code (Code Sec. 195).

Facts of the Case

In 2004, Taxpayer began exploring the real estate investment business:

• May 2004: Taxpayer created a business plan for his venture with “buying, remodeling, and renting property” being its stated purpose.
• Oct. 2004: Taxpayer paid over $20,000 to attend real estate investment training courses.
• Nov. 2004: Taxpayer secured a loan from the U.S. Small Business Administration.
• Dec. 2004: Taxpayer purchased his first investment property, which he did not succeed in renting out until 2005.

On his 2004 tax return, the Taxpayer reported $24,000 of deductible business expenses, including the cost of his training classes, supplies, car expenses, etc. The IRS disallowed these deductions, and Taxpayer appealed to the Tax Court.

No Business Deductions until Business Actually Commences

The Tax Court pointed out that in determining whether a trade or business exists, the courts have examined: (1) whether the taxpayer undertook the activity intending to earn a profit; (2) whether the taxpayer was regularly and actively involved in the activity; and (3) whether the taxpayer’s activity actually commenced. The Tax Court found the third factor to be determinative in Woody’s case.

He may qualify to deduct start-up expenses under Code Sec. 195 rather than ordinary and necessary business expenses under Code Sec. 162 .

The Tax Court pointed out that Taxpayer’s largest expenditure in 2004 – $21,515 for workshops and training – was an educational expense incurred to prepare for a new career, i.e., real estate investor and renter, rather than to maintain or improve skills in an ongoing business or career. It was therefore not deductible under Code Sec. 162.

1 Comment to Important Note for Start-Ups

1. Joaquin Isakson
   March 22, 2010 at 7:18 pm

   […] http://www.glassjacobson.com/2009/05/important-note-for-start-ups/ – Important Note for Start-Ups Glass Jacobson… Home Buyer Tips and Mortgage Calculator Pocket Side Guide: An absolute necessity for every active agent.. … read more at http://www.imagebuilderads.com/ [...]