One of the barriers to starting a business is the cost involved in organizing and getting the business underway. Typically, preliminary expenses incurred while in the decision-making process are not deductible, while similar expenses incurred after the business is underway may be deductible.
The process may take months or even years before a startup begins to function as a going concern, or “active trade or business,” noted tax attorney Barbara Weltman, author of J.K. Lasser’s “Small Business Taxes 2022.”
This point was brought home by the Tax Court in a recent case where a taxpayer was working on matters needed to begin renting space to farmers, she noted. “But, for the year in issue, he hadn’t reached that point, so his deductions were not allowed.”
In 2012 or 2013, Vardan Antonyan purchased 10 acres of property in the middle of the Mojave Desert, approximately one mile from any road and 120 miles from his residence. He intended to develop its natural resources, making it accessible by road, procuring a certification for organic farming, dividing it into parcels, and then renting the parcels to farmers.
Antonyan created a business plan for his venture, which he named Paradise Acres. The plan required him to construct an unlivable outdoor structure similar to a barn on the property. It then required him to obtain certification from the U.S. Department of Agriculture certifying that the land complied with the standards for organic farming, and, finally, provided for the installation of an irrigation system on the property and the construction of an access road.
Sometime before 2015, Antonyan partially installed a water tank and rainwater collection system. In addition, he explored the property, and conducted a number of experiments. He did not claim any deductions for expenses prior to 2015.
During 2015, acting as the general contractor, he began construction of the outdoor structure called for in his business plan. He hired day laborers, purchased building materials, rented an industrial commercial truck and a four-wheel drive tractor-trailer to transport materials to the property, and established an unpaved vehicle access road to the property. During 2015, Antonyan worked full-time as an engineer, so he could only work on the property on weekends.
The Internal Revenue Service disallowed Antonyans’s 2015 schedule C deductions because Paradise Acres was not yet an active trade or business that began in 2015. For example, the service noted that Antonyan never accomplished the first step in his business plan — the construction of the unlivable outdoor structure. The service also emphasized that Antonyan failed to complete the other steps in the plan — namely, the procurement of an organic farming certification and the completion of the irrigation system necessary to grow crops in the barren Mojave Desert.
“Although [Antonyan] explored the property and conducted a number of experiments on it, those actions exemplify steps taken to set up a business; they do not indicate that a business has actually commenced and is presently operating as a going concern,” the court reasoned. “Assuming, arguendo, that none of the steps in [Antoyan’s] business plan was necessary to rent the property, [he] nevertheless failed to produce any evidence to establish that [he] held the property out for rent during 2015.”
“There’s no bright line that identifies when a venture becomes operational,” observed Weltman. “That’s why there are cases, because they’re grappling with that issue of crossing the threshold of being in a trade or business. If you’re still in a pre-opening phase, you’re not in a trade or business.”
