Deduction versus depreciation of start-up costs: “Kellett against the commissioner”

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A “start-up” generally incurs significant expenses before actually exercising its commercial activities. Under subsection (a) of the Internal Revenue Code (Code) §162, the deduction of business or professional expenses is limited to “ordinary and necessary expenses paid or incurred in the tax year in the exercise of a trade or business(emphasis added). Thus, it is only when a trade or business is carried on that expenses can be deducted under this provision. The prohibition of the current deduction of start-up expenses is also explicitly stated in the Code §195, which then allows a deduction for depreciation over a period of 15 years for these expenses, from the actual start of the trade or business. .

It is also common that a substantial part of a start-up’s expenses, whether incurred before or after starting the business, consist of software development costs. Expenses incurred to acquire or increase the value of an asset must, in general, be capitalized (see Code §263(a) and Reg. §1.263(a)-1), in the absence of the application of a specific provision of the Code that may allow more favorable tax treatment. One such provision may be Code §174, which allows a deduction for certain research and experimentation expenses.

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