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Deducting Business Start-Up Expenses for Federal Taxes

While the decision of the U.S. Tax Court in McPartland v. Commissioner is not groundbreaking or surprising, it is a reminder to business start-ups.

Without going into a great deal of detail, what led to the controversy in McPartland involved a rental real estate business. The Taxpayer purchased a property in 2007 for $10,000. That property, as you would imagine, needed a great deal of work before it could be rented as a residence. The Taxpayer incurred nearly $62,000 of expenses associated with renovating the home in 2007 but did not rent the home until 2010.

The Taxpayer deducted the $62,000 of renovation costs as business expenses in 2007, despite the fact that he was not engaged in any business activity during the 2007 tax year. The IRS claimed that these deductions were not legitimate business expenses in 2007 and the U.S. Tax Court agreed.

The Tax Court did not get into the proper treatment of these costs but there is no reason to believe the expenses were not deductible; it is just clear that they were not deductible for 2007. It is important to note that “start-up expenses” should be amortized (deducted over time) for a period of generally 60 months (see IRS Publication 535) and the cost of creating a “Fixed Asset” such as a house, are depreciated over a longer period of time, depending upon the classification of the Fixed Asset.

The lesson to be learned from this case is to discuss the proper treatment of business start-up expenses with a competent tax professional who understands the rules. McPartland had a professional tax preparer, but that preparer obviously did not understand the rules as pertain to this matter.

Please contact a Michigan business attorney at Penzien & McBride, PLLC if you have any questions regarding the proper steps for setting up your business venture.