In the case of Toth v. Commissioner (128 T.C. No. 1, 1/18/2007) the court upheld the treatment of deductible expenses for the production of income as operating expenses and do not have to be capitalized as start-up expenditures. A summary of the case follows:In 1998, the taxpayer began operating a horse boarding and training facility for profit. Although income from the activities in 1998 was modest, it gradually increased as improvements were made to the property and the taxpayer was able to hire additional staff.
The taxpayer contended that the horse boarding and training expenses were deductible as expenses for the production of income in the year paid or incurred. The IRS stipulated that the income reported on the federal income tax returns for 1998 and 2001 was correct and did not dispute the amounts of the expenses claimed. The IRS conceded the taxpayer engaged in activities for profit beginning in 1998. However, the IRS contended the expenses were nondeductible start-up expenditures that must be capitalized, because the taxpayer anticipated that her income-producing activities would become an active trade or business. The court held that the taxpayer expenses are currently deductible. The court construed the term “start-up expenditure” to denote an expenditure that is capital, rather than ordinary. The court said in determining whether an expenditure was a start-up expenditure, it would treat for-profit activities similarly to how trade or business expenses are treated. As a result, the court said, the start-up expenditure rule would not override the deductibility of ordinary and necessary expenses incurred in a for-profit activity. Noting the IRS concession, the court found the taxpayer operated her horse boarding and training activities for profit in 1998 and continued to engage in these same activities through the date of trial. The court concluded that once a for-profit activity begins, the deduction of ordinary and necessary expenses paid or incurred in that activity is not treated as a start-up expenditure, regardless of whether that activity is subsequently transformed into a trade or business.