Amortizing and Deducting Partnership Organization Costs

Editor:
Albert B. Ellentuck, Esq.
Of Counsel
King and Nordlinger, L.L.P.
Arlington, VA

Editor’s note: This case study has been adapted from PPC Tax Planning GuidePartnerships, 16th Edition, by Grover A. Cleveland, James A. Keller, William D. Klein, Terry W. Lovelace, Sara S. McMurrian and Linda A. Markwood, published by Practitioners Publishing Company, Fort Worth, Tex., 2002 ((800) 323-8724; www.ppcnet.com).

Facts: Bert and Ernie formed Burntside Golf Club, a calendar-year partnership, to purchase and operate a golf course. Burntsides golf course opened under the new ownership on Feb. 1, 2003. In addition to other expenses incurred before the business began, Burntside paid $2,500 to attorneys to draft its partnership agreement, $500 to accountants to organize its books and $3,000 in wages to prepare and maintain the golf course before opening. Issue: Can Bert and Ernie deduct the expenses incurred in organizing their partnership?

Analysis

Generally under Sec. 709(a), partners cannot deduct partnership organization expenses; such costs must be capitalized. However, Sec. 709(b) permits partnerships to elect to amortize organization costs over not less than 60 months, beginning with the month in which the partnership commences business. Organization costs eligible for amortization are expenses:

1. Incident to partnership creation.

2. Chargeable to a capital account.

3. Of a character that, if the partnership had an ascertainable life, would be amortized over that life. The item must be expected to benefit the partnership throughout its entire life.

An expense must be incurred during a period that starts a reasonable time before the partnership began business and ends on the due date (without extensions) for the return for the partnership year in which the partnership began business. Eligible expenses include filing fees, legal fees to negotiate and draft a partnership agreement, and accounting fees to organize the partnership. Expenses of acquiring assets, business start-up costs and syndication expenses are ineligible.

The amortization period begins in the month business commences. Regs. Sec. 1.709-1(b)(1) bars a cash-basis partnership from amortizing an expense until paid. Any amortization expense for periods before the year in which the organization costs are paid is deductible in the year of payment.

If the partnership is liquidated before the amortization period ends, the unamortized portion of the organization costs generally could be deducted under Sec. 165 as a business loss in the liquidation year. If the amortization election is not made, however, these expenses could not be deducted as a business loss. According to Rev. Rul. 87-111, these amounts, having been capitalized and included in the partners tax basis, will provide a tax benefit only by creating or increasing a capital loss, or reducing a capital gain recognized on the liquidation of the partnership or a partners interest.

Burntside Golf Club can elect to amortize the $3,000 of organization costs incurred to draft the partnership agreement and set up the partnership books, over not less than 60 months, commencing in February 2003. A tax adviser will usually suggest that the partners select this 60-month period, as it is the most rapid schedule available. If Burntside Golf Club elects a 60-month period, 11/60 of its amortizable expenses ($550) is deductible for 2003.

If Burntside is a cash-basis partnership and the $500 accounting fee is not paid until 2004, its 2003 amortization deduction must exclude the portion of the total organizational costs attributable to that fee (11/60 of $500, or $91.67). That deduction is deferred until 2004, the year of payment.

The wages paid for pre-opening golf-course upkeep do not constitute a partnership organization cost. However, the cost may be amortizable under similar rules as a business start-up cost under Sec. 195.

Because the nature of an expense determines whether it is eligible for amortization as an organization cost, tax advisers should suggest that clients keep detailed records to substantiate the amount and nature of such expenses. Moreover, a practitioner can assist in justifying the largest reasonable allocation to such costs.

In the case of a syndicated partnership, for example, Rev. Rul. 88-4 states that some expenses may be either amortizable organization costs or nondeductible syndication expenses. Accounting services may relate to setting up partnership books and accounting systems (amortizable) or to preparing financial projections or other representations to prospective investors (nondeductible). Legal expenses can relate to preparing and filing partnership documents (amortizable) or to providing securities advice and preparing and filing offering materials (nondeductible). Professional expenses can relate to tax advice as to the partnerships structure (amortizable), preparation of a tax opinion or other legal disclosures, or to promote marketing interests to prospective investors (nondeductible).

By becoming involved early, a tax adviser may be able to help the partners negotiate and document the arrangements for these services to support the largest reasonable allocation to amortizable (rather than nondeductible) expenses.

Conclusion

Partnerships can elect to amortize organization costs over a 60-month period beginning with the month in which the partnership commences business. Of Burntside Golf Clubs pre-opening expenses, $3,000 qualifies as amortizable organization costs (and $3,000 probably qualifies as amortizable start-up costs).

Forms, Elections and Implementation

A partnership electing to amortize organization costs must attach a statement to its timely filed (including extensions) original return for the year in which the partnership began business. The statement must include:

1. A description of each expense of $10 or more.

2. The date such expense was incurred.

3. The aggregate amount of expenses of less than $10 each.

4. The month during which the partnership began business.

5. The number of months in the amortization period the partnership elected.

While the election statement must be attached to the partnerships original return, the return may be amended later to include additional expenses.