Simple Start Up Cost Question

This is one of those "afraid to ask" questions because I should know.

Client is a legitimate start-up brewery and is a partnership.

In 2018, I capitalized the start up costs.

Now it's time to complete 2019 and they have another $50,000 in operating expenses and $60,000 in brewery equipment.

But no sales.

The partners have income form their day jobs that will be offset by the loss from the partnership.

Must I amortize the $50,000 start up costs in 2019 again?

Do I depreciate the equipment as normal or do I include that in the 15 years too?

Thanks as always.

Well, are they open for business? (figuring not...so the worst you expected 'tis true.)

Not open in 2019, no.

So it's ALL to be amortized over 15 years, I'm assuming?

Start up costs rules apply each year until a business opens?

(I know there's also a "hobby" rule, of course but that's another discussion).

Is the cost of the brewery equipment really a start-up expense?

https://www.thetaxadviser.com/issues/20 ... costs.html

Nothing gets deducted, amortized, or depreciated until the active trade or business commences with the possible exceptions of section 163, 164, and 174 expenses.

Thanks for your replies and the link!

So I'm totally fine with doing my own research, and what I get out of these answers and other searches is that:

1) Until the business actually starts operating, they can't take depreciation on this equipment - and these items are not start up costs or currently deductible - so no they get no deduction, depreciation, or amortization at all. That is until the doors open up for business.

2) The remaining 'current' costs may or may not be start up costs depending on their nature - but they generally seem to fall into deductible expenses, and thus I plan to amortize most of them over 15 years.

Please stop me if that sounds way off.

Thanks again!

The second category also doesn't get amortization (and $5k expensing if applicable) until the active trade or business commences. Only interest, taxes, and research & experimentation costs can be deductible before the active trade or business commences.

Ah - lighbulb went on. Thanks for your help, oh my goodness.

I see they have no sales, but have they started brewing? I would think start up ends when brewing begins.

I know the brewing process is short so if they say they started brewing then you need to ask why no sales yet.

I know the brewing process is short so if they say they started brewing then you need to ask why no sales yet.

Not to get off topic, but it depends on what type of beer they're brewing.

Some takes years to age and mature. Home brewing is one of my hobbies, although it's taken a far back seat in recent years.

Good point otherwise.

Nothing gets deducted, amortized, or depreciated until the active trade or business commences with the possible exceptions of section 163, 164, and 174 expenses.

To resurrect this old post, and to cap off my nearly three hours of research on this topic , I ask the following question:

Are IRC §174 research and development expenses really deductible prior to the commencement date of a business?


Per Mayrath v. Comm'r of Internal Revenue:

https://casetext.com/case/mayrath-v-com ... al-revenue

In John F. Koons, 35 T.C. 1092 (1961), we stated that the statutory phrase ‘trade or business' presupposes an existing business with which the taxpayer is directly connected and that expenditures for research and experimentation that are preliminary to the establishment of a business do not qualify as deductions under section 174. We think the statute was intended to be used in the realistic and practical sense of a going trade or business—a condition which does not exist here.

Per Koons v. Comm'r of Internal Revenue:

https://casetext.com/case/koons-v-commr ... al-revenue

It is our view that section 174(a)(1) applies to expenditures for research and experimentation in connection with an existing business to which such research and development is proximately related, such as the development or improvement of its existing products or services, or the development of new products and services in connection with such trade or business. We do not suggest that these generalities are all-inclusive. In the instant case, however, there was no such existing trade or business. The research and experimentation was no doubt in anticipation of the organizing of a business to make business use of an end product when it reached the point of commercial acceptability. At the time the invention was bought by petitioner, however, it was in preliminary laboratory state, and petitioner entered into the so-called Development Contract in part, at least, to get the benefit of research specialists. He went no further than this in 1955, however. It is our view that this activity was preliminary to the coming into existence of a business, and did not reach the stage of an existing business in the year in question within the meaning of section 174(a)(1). The research and development expenditures could not be ‘in connection with’ a business which did not exist.

It is clear that the statutory phrase ‘trade or business' presupposes an existing business with which the taxpayer is directly connected. Expenditures made in investigating a potential new trade or business, or preparatory to entering into such business, do not, in our opinion, qualify for the application of section 174(a)(1). The principle is recognized in our repeated disallowance of such expenditures. See Dwight A. Ward, 20 T.C. 332, 343 (1953), affirmed on another issue 224 F.2d 547 (C.A. 9, 1955); George C. Westervelt, 8 T.C. 1248, 1254 (1947); Henry G. Owen, 23 T.C. 377, 381 (1954); Morton Frank, 20 T.C. 511, 513-514 (1953); Eugene H. Walet, Jr., 31 T.C. 461, 471 (1958), affd. 272 F.2d 694 (C.A. 5, 1959). See also McDonald v. Commissioner, 323 U.S. 57 (1944.)

In the light of the foregoing discussion, it is our view that the research and experimental expenditures in issue were not paid or incurred by petitioner during the taxable year in question in connection with an existing trade or business and that petitioner has not established that he is entitled to the benefits of section 174(a)(1).

It is only because it's past 1:00AM that I have the audacity to question the almighty Coddington.

See irc 195 - “active” trade or business test applies to startup costs. 174 applies to costs “in connection with the taxpayer’s trade or business”.

So, a trade or business is required for 174 - it just doesn’t need to be “active” (yet).

But I’m sure Coddington could add much more clarity.

See irc 195 - “active” trade or business test applies to startup costs. 174 applies to costs in connection with the taxpayer’s trade or business”.

So, a trade or business is required for 174 - it just doesn’t need to be “active” (yet).

But I’m sure Coddington could add much more clarity.

But if the business is not yet active, how can you be assured the taxpayer has a trade or business for 174?

These two cases should clear up the limits of section 174:

Snow v. Comm’r, 416 U.S. 500 (1974).

Mach-Tech, Ltd. v. Comm'r, 95-2 U.S. Tax Cas. (CCH) P50,375 | 76 A.F.T.R.2d (RIA) 95-5439 (5th Cir. 1995).

Thank you all for the responses. I'm noticing that the Tax Court seems to have warmed up to the idea of IRC §174 deductions being applicable to pre-commencement businesses more recently given that the dates of the cases are as follows:

1961 -- Koons v. Comm'r of Internal Revenue

1964 -- Mayrath v. Comm'r of Internal Revenue

1974 -- Snow v. Comm’r

1994 -- Mach-Tech, Ltd. v. Comm'r

Snow was the Supreme Court. The Tax Court didn’t have a choice but to warm up.

Ahh, makes sense. Thank you -- your help is much appreciated!

But if the business is not yet active, how can you be assured the taxpayer has a trade or business for 174?

Well, having a business for Sec 174 purposes, assuming one doesn’t already exist, would be developed by the record. If the guy is developing an incinerator (like Snow was) and he says (like with most inventions), “I intend to market and sell the final product and this invention isn’t for personal purposes,” then there’s an expectation of a future business, making the costs incurred “in connection with” that future trade or business. It was also pretty self-evident in a case like Snow, given that the loss flowed through from a limited partnership. Those (limited partnerships) are not formed for personal purposes. Those have investors who are trying to make money.

Here are the oral arguments from the Snow case (and the oral opinion), have a listen:

https://www.oyez.org/cases/1973/73-641

And from the oral opinion:
The history of Section 174 (a) (1) which allows experimental expenditures which are paid or incurred during the taxable year in connection with the trade or business was put in by Congress in 1954, precisely we think to aid the new long coming struggling pioneers who had not yet produced their business, but were on their way to that end.

That was passed by Congress according to the legislative history to equalize the tax opportunities of the little oncoming business as compared with the established business that had research and development departments all of whose expenses were deductible

As to this point:

Snow was the Supreme Court. The Tax Court didn’t have a choice but to warm up.

Yeah, and if Snow didn’t appeal his case to the Supreme Court, somebody else would have.

And, as has been mentioned on other occasions on this forum, when you see “in connection with” language in a form of tax guidance, that is a much lower standard than, say, Sec 162, which speaks to “carrying on” a trade or business.

Thanks again for the insights -- all of the feedback is extremely helpful as usual!