Expenses

Sec. 212 Expenses Deductible Prior to Becoming Trade or Business

P is one of six individuals in the Pacific Northwest qualified to teach eventing at the beginning novice, novice, training and preliminary levels. In 1998, she purchased 17 acres of land and began operating a horse boarding and training facility for profit. Income from those activities was modest, increasing to approximately $3,000 per month in 2004.

P contends that the 1998 horse boarding and training expenses are deductible under Sec. 212. The IRS concedes that P engaged in horse boarding and training activities for profit beginning in 1998, but contends the expenses are nondeductible start-up expenditures under Sec. 195(a).

Law

Sec. 195 provides:

(a) Capitalization of Expenditures. Except as otherwise provided in this section, no deduction shall be allowed for start-up expenditures….

(1) Start-up expenditures. The term “start-up expenditure” means any amount—

(A) paid or incurred in connection with— …

(iii) any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business...(Emphasis added.)

The Service contends that, under the cited portions of Sec. 195, the expenses paid or incurred in the income-producing activity must be capitalized, because P anticipated that the income-producing activities would become an active trade or business. However, this argument fails, for several reasons.

First, this court construes the term “start-up expenditure” to denote one that is capital rather than ordinary. This court will not interpret Sec. 195 to override the deductibility of ordinary and necessary expenses P incurred in an ongoing Sec. 212 activity, any more than it would for an ongoing Sec. 162 activity.

Because P’s Sec. 212 activity had begun, Sec. 195 does not preclude the deduction of ordinary and necessary expenses paid or incurred in that activity, regardless of whether that activity is subsequently transformed into a trade or business.

This interpretation is consistent with Sec. 195 and its legislative history. Prior to the Sec. 195 effective date, several courts of appeals were asked to decide whether expenses paid or incurred during the pre-operating phase of a profit-seeking activity were deductible or had to be capitalized. Six courts of appeals held that, because Sec. 212 and Sec. 162 are in pari materia, pre-opening expenses for either a Sec. 212 or 162 activity must be capitalized. However, the Ninth Circuit affirmed a Tax Court holding that found pre-opening expenditures of a Sec. 212 activity could be deducted; see Hoopengarner, 80 TC 538 (1983), aff’d w/o pub. op., 745 F2d 66 (9th Cir. 1984).

Subsequently, Congress amended Sec. 195 to require expenses similar to those allowed as deductions in Hoopengarner to be capitalized; see S Rep’t No. 98-169, 98th Cong., 2d Sess. (7/18/84). Thus, the purpose of the 1984 amendment was to bring Secs. 212 and 162 into parity when determining whether a pre-opening expenditure has been incurred in a start-up activity.

Conclusion

P operated her horse boarding and training activities for profit in 1998 and has continued to engage in these same activities through the date of trial. The IRS concedes that P engaged in these activities for profit during the years at issue. It does not argue the application of Sec. 183 and does not dispute the amounts of the expenses or that they were ordinary or necessary. Thus, P’s expenses attributable to her horse boarding and training activities during the years at issue are deductible pursuant to Sec. 212.

Julie A. Toth, 128 TC No. 1 (1/18/07)