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When can be start deducting expenses incurred during startup

phase? We have been constructing a...
When can be start deducting expenses incurred during startup phase?
We have been constructing a preschool for the last 2 years and we are nearly done with construction. We have incurred several expenses during the last 2 years.
For realizing these expenses, what's the crititeria?
Is getting occupancy permit good enough or should the business be up and running?
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Answered in 1 minute by:
10/3/2013
Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,246
Experience: Extensive Experience with Tax, Financial & Estate Issues
Verified

Stephen G. :

Hello, my name isXXXXX & I'll be helping you today. My goal is to give you a complete & accurate answer that you can understand.

Stephen G. :

I presume that you are talking about expenses other than the direct or indirect construction costs?

Customer:

Hi steve

Customer:

Yes. I am referring to the loan interest, utilities, construction cost

Stephen G. :

If so, the business should be operating before you start to amortize start-up costs.

Customer:

If we complete the construction and don't start the business, what expenses can be deducted?

Stephen G. :

Loan interest & utilities are all construction costs.

Stephen G. :

What will you do with the property?

Customer:

Since we are getting close to the end of the year, if the daycare license gets delayed we may not opening the business this year

Customer:

This is a preschool

Stephen G. :

Just about everything, except personal expenses, can be deducted against the sale of the property.

Customer:

No.we are not planning to sell the property.

Stephen G. :

Before you begin operations, just about everything is either construction cost or start-up costs.

Stephen G. :

So, when the building is placed in service, depreciation starts. When you begin operations, the amortization of start-up costs begins.

Stephen G. :

Do you have any examples of what type of costs you are talking about?

Customer:

I am referring to utilities, loan interest,

Stephen G. :

OK, I answered that one. The loan interest would follow whatever the costs were that you incurred with the borrowing; so, if you purchased equipment, that's an additional cost of the equipment; construction materials, that's an additional construction cost; utilities during construction are construction costs just like wood, steel, drywall, whatever.

Customer:

How about playground equipment, landscaping materials

Stephen G. :

That's all construction costs or equipment or land improvements;

Stephen G. :

While awaiting your response, I started to review your prior questions; what's the status of what's going on now; do you have a new CPA on board; these aren't decisions you should be making alone; it sounds like you are having disagreements with your partners;

Customer:

Is there any other way to deduct expenses this year even if the business doesn't open this year? May be renting for a part of the month?

Stephen G. :

What in the world could possibly generate a 50,000 penalty on a partnership return other than not filing? the partnership doesn't pay taxes;

Stephen G. :

What do you mean renting?

Customer:

Actually I found that this notice is not real

Customer:

Renting a classroom for some activities

Stephen G. :

You mean starting operations in another location?

Customer:

No. same location.

Stephen G. :

You mean renting part of your building out to someone else?

Customer:

Yes

Stephen G. :

So you'll have rental income; what's the question?

Customer:

My question is can we start amortization of startup costs?

Stephen G. :

No. Start-up costs relate to your business, not a building. If you place a portion of your building in service to lease it out, then you would start to depreciate that portion of the building for the period you rent it. At this point, that's not going to amount to very much.

Customer:

We have incurred over 100K expenses in loan interest and utilities alone. I was trying to find a way to deduct these expenses, instead of waiting for next year. Is there any other option?

Stephen G. :

Do you have a CPA on board now? This whole process involves allocations, etc. and he/she will have to pick-up where your amended returns left off; this isn't a simple problem, especially if you start renting a portion of your building rather than operating your business in it;

Stephen G. :

You aren't going to get to deduct those expenses as expenses; they should be capitalized as part of the construction and depreciated over the building's , recovery period just like any other construction cost.

Customer:

We have a new CPA onboard now. I wanted to get a second opinion since my partner is very close to this CPA. My partner is trying to delay opening of the business to prevent me from deducting expenses for this year

Stephen G. :

It sounds to me like you have bigger problems than depreciation/amortization; how in the world are you going to conduct a successful business with this kind of animosity between the partners? You are going to find that even if you start the business this year, the deductions you are talking about (depreciation & amortization) aren't going to be significant because they will be spread out over an extended period.

Stephen G. :

Either you trust the CPA, or you need to get your own CPA or both agree to get another one; Any CPA that screws around with figures for one partner over another is risking a lot more than an upset partner; He would have to be crazy to do so; it just doesn't make sense; look what happened to the first CPA you had? I bet that there is more to that story too.

Stephen G. :

What you need to understand is that there's a big difference between how expenses are treated before you begin operations and after, when they become currently deductible as operating expenses.

Stephen G. :

Questions?

Stephen G. :

If you need to contact me again with any tax or financial questions, you can just ask for "Steve G" at the beginning of your question. Thanks again for using us for your tax and financial questions. You may get a short survey from the site; if it isn't too much trouble I would appreciate it if you would answer it; the survey results are used to rate our performance;

Customer:

If mortgage interest is deductable 100% (if business opens this year) that's going to be a significant - over $100K. Yes. we need to get our act together.

Stephen G. :

Mortgage interest during the construction is not deductible; Construction period interest must be capitalized into the cost of the building.

Stephen G. :

The only interest that would be currently deductible would be the interest incurred and paid after the business is operating.

Stephen G. :

So you aren't talking about 100K of interest expense being deductible this year.

Stephen G. :

It appears that the two of you are arguing over something that doesn't exist; ie. big tax deductions if the business is started this year. That simply not the case.

Customer:

What happens to the interest paid before opening the business? Will this be capatilzed?

Stephen G. :

Yes. That is exactly what happens.

Customer:

In case we sell the property before we open the business, can we deduct all expenses incurred so far from the total sale price?

Stephen G. :

Yes.

Customer:

One final question regarding the so called penalty. Does IRS impose a penalty for the errors on the original return even if we have amended the returns voluntarily? I am referring to the LLC tax returns

Stephen G. :

Sure, they can, but that doesn't mean you have to accept the penalty without protesting it. We would normally write a letter requesting that any such penalty be abated for reasonable cause. Since you had a CPA prepare & sign the original returns, it should be a relatively simple exercise to get any accuracy penalty abated.

Stephen G. :

I thought you said the penalty wasn't real?

Customer:

Yes. My partner said he hasn't received anything yet. I would like to know if there's a chance that this could happen.

Stephen G. :

There are very few penalties that would accrue to an LLC filing as a partnership. Then penalties would be assessed at the individual level where the tax is paid.

Stephen G. :

I doubt the LLC will be penalized; the preparer would more likely be subject to preparer penalties; those are more severe as a CPA should know better;

Customer:

At the individual level, I took care of all taxes, interest and also penalty. I am concerned about the LLC tax return, since my partner is blaming me including charges of fraud (that I worked with our original CPA)

Stephen G. :

You aren't required to be a tax expert; you are entitled to rely on a qualified expert; that's the CPA; even if he's totally wrong, that's not your problem.

Stephen G. :

There's no fraud; fraud requires intent;

Stephen G. :

What penalties did you pay at the individual level?

Customer:

My partner says that I signed the return without reviewing or asking him to review.He also says I told the original CPA that the business is already running - which is totally false.

Stephen G. :

Were they assessed by the IRS, or did you submit penalties with your amended returns?

Stephen G. :

Has your partner amended his returns, if you know?

Customer:

You mean personal tax returns? No. I paid voluntarily and was not assessed.

Stephen G. :

What penalties did you pay voluntarily? When did you file the amended returns?

Customer:

However another CPA (who amended my individual tax returns) filed an abatement request for waiving penalty. I paid $10K in penalty

Customer:

My partner amended his 2011 personal tax return.

Customer:

2012 he had applied for extension and so is not impacted by the amended LLC tax return

Stephen G. :

Well, it would be impacted, because the tax that is due has to be paid by 4/15 or technically the extension is not valid.

Customer:

I assume he paid all his taxes for 2012

Stephen G. :

What is your "partner's" real motivation to be a total jerk about all of this?

Stephen G. :

Yes, he probably did, but he wouldn't have had the correct numbers by 4/15/13 would he have?

Customer:

I think he is paranoid if IRS will come after him (since he is also a member) for the incorrect LLC tax returns

Customer:

I think he assumed there's no losses from the LLC and so may not owe any additional taxes.

Stephen G. :

You (& he) have gotten and are still getting all cranked up about something that is very unlikely to become a real problem. You both should be working on the school & forget about the IRS. You had a CPA on board; there's where the problem is going to arise, if it arises at all. When you found out there was a problem, you fixed it. That's the smartest thing you did.

Stephen G. :

By the way, you aren't required to appoint a TMP, and if I were you, I wouldn't do so in the future.

Customer:

Yes. I agree. I have clearly mentioned that I don't want to be a TMP any more in the future.

Customer:

To make things worse, my partner says he is not going to open the business unless the tax issues are resolved.

Stephen G. :

A TMP in practical terms (as far as the IRS is concerned) is merely a contact for them to reach; it doesn't fix or change liability;

Stephen G. :

What tax issues?

Customer:

The fact that the original taxes filed were incorrect (my partner calls them fradulent)

Customer:

He wants to know what exactly happened.

Stephen G. :

The IRS doesn't "bless" tax returns. You may never hear from them. They are likely to accept the amended returns and your money and that's it.

Stephen G. :

I'll tell you one thing, I wouldn't want to be his partner in any way shape or form. Wait until some kid gets hurt, is that going to be your fault too?

Customer:

So we may never hear from IRS regarding our amended LLC tax returns?What money back you are referring to

Stephen G. :

Correct. No money back; the money you sent with your amended returns. You will hear about your CPAs request for penalty abatements & if you paid penalties you will get those back if the abatement is accepted.

Customer:

For the amended LLC tax returns, we never sent any money. I paid penalty on my personal amended tax return.

Stephen G. :

Right. I understand. That's normal, makes sense.

Customer:

Even if the margin of error was huge on the original LLC tax return, you are saying that we should be fine, since we amended our LLC returns voluntarily?

Stephen G. :

No. What I'm saying is that if anyone is going to penalized it is most likely the CPA who prepared the returns.

Stephen G. :

OK, are you all set for now?

Customer:

One final question. If IRS starts an investigation and if my partner blames me and if my CPA (who did the original returns) also doesn't support me, would I be in trouble?

Stephen G. :

In my opinion and experience No. What matters is what the CPA did or didn't do.

Customer:

The reason is that my partner says I told our CPA that the business already started. I am concerned if the CPA is trying to save himself by implicating me.

Stephen G. :

I wouldn't believe anything your partner says at this point. There's nothing you can do except tell the truth; based upon our limited exchange here, I don't think you would have known the difference between how things would have been handled if the business had started or not. It should have been obvious from the numbers that the business was still under construction.

Customer:

Thanks a lot for patiently answering all my questions. Much appreciated

Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,246
Experience: Extensive Experience with Tax, Financial & Estate Issues
Verified
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Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 7,246
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