Tax has
something called “startup costs.”
The idea is
to slow down how quickly you can deduct these costs, and it can hurt.
Let’s take a
common enough example: starting a restaurant.
You are
interested in owning a restaurant. You look at several existing restaurants
that may be available for purchase, but you eventually decide to renovate
existing space and open your own- and new – restaurant. You lease or buy, then hire
an architect for the design and a contractor for the build-out of the space.
You are
burning through money.
You still do
not have a tax deduction. Expenses incurred when you were evaluating existing
restaurants are considered investigatory expenses. The idea here is that you were
thinking of doing something, but you were not certain which something to do –
or whether to do anything at all.
Investigatory
expenses are a type of startup expense.
The
contractor comes in. You are installing walls and windows and floors and
fixtures. The equipment and furniture are delivered next.
You will
depreciate these expenses, but not yet. Depreciation begins when an asset is
placed in service, and it is hard to argue that assets are placed in service
before the business itself begins.
You still do
not have a tax deduction.
You will be
the head chef, but still need your sous and line chefs, as well as a hostess,
waitpersons, bartender and busboys. You have payroll and you have not served your
first customer.
It is relatively
common for a restaurant to have a soft launch, meaning the restaurant is open
to invited guests only. This is a chance to present the menu and to shakedown
the kitchen and floor staff before opening doors to the general public. It
serves a couple of purposes: first, to make sure everyone and everything is
ready; second, to stop the startup period.
Think about
the expenses you have incurred just to get to your soft launch: the
investigatory expenses, the architect and contractor, the construction costs,
the fixtures and furniture, employee training, advertising and so on.
Carve out
the stuff that is depreciable, as that has its own rules. The costs that are
left represent startup costs.
The tax Code
– in its wisdom or jest – allows you to immediately deduct up to $5,000 of
startup costs, and even that skeletal amount is reduced if you have “too many”
startup costs.
Whatever
remains is deductible pro-rata over 15 years.
Yes, 15
years. Almost enough time to get a kid through grade and high school.
You clearly want
to minimize startup costs, if at all possible. There are two general ways to do
this:
· Start doing business as soon as
possible. Perhaps you start takeout or
delivery as soon as the kitchen is ready and before the overall restaurant is
open for service.
· You expand an existing business, with
expansion in this example meaning your second (or later) restaurant. While you
are starting another restaurant, you are already in the business
of operating restaurants. You are past startup, at least as far as restaurants
go.
Let’s look
at the Safaryan case.
In 2012 or
2013 Vardan Antonyan purchased 10 acres in the middle of the Mojave desert. It
was a mile away from a road and about 120 miles away from where Antonyan and
his wife lived. It was his plan to provide road access to the property, obtain
approval for organic farming, install an irrigation system and subdivide and
rent individual parcels to farmers.
The place was going to be called “Paradise Acres.” I am not making this up.
Antonyan
created a business plan. Step one was to construct a nonlivable structure
(think a barn), to be followed by certification with the Department of
Agriculture, an irrigation system and construction of an access road.
Forward to
2015 and Antoyan was buying building materials, hiring day laborers and renting
equipment to build that barn.
Antoyan and
his wife (Safaryan) filed their 2015 tax return and claim approximately $25
thousand in losses from this activity.
The IRS
bounced the return.
Their argument?
The business
never started.
How did the IRS
get there?
Antonyan
never accomplished one thing in his business plan by the end of 2015. Mind you,
he started constructing the barn, but he had not finished it by year-end. This did
not mean that he was not racking-up expenses. It just meant that the expenses
were startup costs, to be deducted at that generous $5,00/15-year burn rate
starting in the year the business actually started.
The Court
wanted to see revenue. Revenue is the gold standard when arguing business
startup. There was none, however, placing tremendous pressure on Antonyan to
explain how the business had started without tenants or rent – when tenants and
rent were the entirety of the business. Perhaps
he could present statements from potential tenants about negotiations with
Antonyan – something to persuade the Court.
He couldn’t.
Meaning he
did not start in 2015.
Our case
this time was Safaryan v Commissioner, T.C. Memo 2021-138.
