If I open a new LLC in December of 2023, and purchase capital for that LLC in December, but don't make any revenue until 2024, can I fully deduct the Dec 2023 capital expense from my taxable income in 2024, without depreciating it over several years?
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Let's start with the date the business begins as an active, ongoing enterprise. You are actively looking for clients, performing work, etc. even if you haven't been paid yet.
Anything before that is "startup costs."
If your business is active and ongoing before the end of 2023, then you file a schedule C to report your expenses. If you have no income, you will show a loss, that can be carried forward to offset profits in future years. Your costs before you started the business are startup costs. If they are $5000 or less, you can deduct them in the first year. If more than $5000, you deduct them partly in the first year and partly spread out over 15 years.
However, if you are not actively pursuing the business in 2023, then you hold onto your startup costs, and report them on schedule C in the first year the business is active (presumably 2024). You would not have a schedule C in 2023.
(I wrote this assuming it was a single member LLC disregarded entity. If this is a multi-member LLC or you made the election to be taxed as an S-corp, I don't know if the rules are different.)
Note that capital equipment is handled separately from other startup costs. Equipment is placed in service for depreciation as of the date the business is open/actively ongoing in the usual manner for equipment, including the options for the $2500 safe harbor, bonus depreciation and section 179 depreciation, if you are otherwise eligible. Other startup costs like legal fees, advertising, paperwork, building your web site, and so on, would be deducted or spread out over 15 years as mentioned.
What do you mean a "capital expense" ? Did you purchase depreciable assets ? If so you have options ... bonus depreciation or regular depreciation but without income the 179 deduction would be limited to the income on the business with the rest carried forward. Before take a loss or a possible NOL on the return reflect all your options carefully. You may want to talk to a local tax pro to get educated on these matters and others.
Thank you for such a detailed and quick response!
If I may seek further clarity, let's say the December capital expense is $20,000, but it doesn't arrive until mid January, and the business does not have any "activity" or "work performed" whatsoever until 2024. Would this still make the business qualify as "active" in 2023? And if so, would that mean it would have a Net Operating Loss in 2023, and that the capital needs to be depreciated over 15 years starting in 2024?
Also, if the business only lasted 3-5 years, would there be any way to ever fully deduct the cost of that asset, since it wouldn't reach 15 years of maturity?
If you did not have any income, no expenses and the capital asset was not placed into service in 2023 then you have nothing to report on a 2023 tax return.
As for the asset ... if you have a machine that has a 7 year life and you take it out of service before it is fully depreciated you may need to recapture some of the depreciation taken if you use an accelerated method of depreciation.
@davisyates11 wrote:
Thank you for such a detailed and quick response!
If I may seek further clarity, let's say the December capital expense is $20,000, but it doesn't arrive until mid January, and the business does not have any "activity" or "work performed" whatsoever until 2024. Would this still make the business qualify as "active" in 2023? And if so, would that mean it would have a Net Operating Loss in 2023, and that the capital needs to be depreciated over 15 years starting in 2024?
Also, if the business only lasted 3-5 years, would there be any way to ever fully deduct the cost of that asset, since it wouldn't reach 15 years of maturity?
The IRS says this, for example.
A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit. The facts and circumstances of each case determine whether an activity is a trade or business. Some of the important facts and circumstances used to make this determination include:
You do not need to make a profit to be operating a trade or business but you do need to have a profit motive.
Suppose you want to print advertising fliers and other materials for other businesses. Just ordering the printer and paying for it is probably not enough to be in business. If you begin advertising and taking orders in December (being sure to tell your customers that there will be a delay until the printer arrives) then you would be in business because of the regularity and ongoing efforts tests, for example. But if you don't start taking orders until January, then you aren't in business until January. It can be a little fuzzy, if you are unsure, seek your own professional advice.
Also, if the business only lasted 3-5 years, would there be any way to ever fully deduct the cost of that asset, since it wouldn't reach 15 years of maturity?
Not really. If not used for business for its entire useful life, why would you get the entire value as a business expense?
Let's consider two situations.
1. You take normal depreciation, if the life is 15 years that's roughly $1300 per year (I'm aware it's a bit more complicated than that, but let's keep it simple.). After 5 years, you have depreciated roughly $7000 and the remaining cost basis is $13,000. You close the business. What do you do with the equipment? Suppose you sell it used to another business for $10,000. You have a $3000 loss (from your cost basis) that you can deduct as a business expense on that year's tax return. Or suppose you sell it for $14,000. You have a $1000 gain which is taxable business income. (Because you sold for more than you adjusted cost basis.). Or suppose you keep the business running, but the equipment has become obsolete because of changing technology and you throw it away. You can take the remaining depreciation at that time (because you have "used up" all the useful life, you can deduct the entire cost.)
2. Suppose you take section 179 or some other kind of special depreciation which allows you to depreciate the entire cost in the first year. Your cost basis is now zero. What happens when you close the business in 5 years? If you sell the equipment for $10,000, you have $10,000 of taxable business income (because more than your adjusted cost basis.) If you sell the equipment for $14,000, you have $14,000 of taxable business income (same reason). If the equipment is obsolete and you sell it to a scrap yard for $10 scrap metal, you have $10 of taxable income. (I am ignoring salvage value, again, this is an oversimplification for illustration purposes.)
Does this help?
Yes, that is very helpful thank you!
I also reviewed the IRS website, which states: "You begin to claim depreciation when your property is placed in service for either use in a trade or business or the production of income."
So with that in mind, I should be able to purchase the asset in December, begin using it in January, and take the 179 election to deduct the full value (since it's under $1.16M) in 2024, when it is placed into service. Do you see anything I might be oversimplifying there?
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