This appeal by the Internal Revenue Service from a decision by the Tax Court requires us to decide whether the costs incurred by an individual in starting a business may be deducted as current expenses (rather than having to be capitalized) under section 212(2) of the Internal Revenue Code, which allows an individual to deduct “all the ordinary and necessary expenses paid or incurred during the taxable year ... for the management, conservation, or maintenance of property held for the production of income.”
The taxpayers formed a partnership to develop a shopping center on a piece of land which they did not own. In August 1976 the partnership obtained a standby commitment from a bank for a permanent mortgage, paying a $9,000 commitment fee to the bank and a similar fee to a broker. In September the partnership leased the development site from the owner for 50 *311 years, at a monthly rental, beginning immediately, of $2,500. In November it obtained a commitment from a bank for a construction mortgage fee of $9,000, half of which was paid in 1976 and the other half in 1977. The partnership incurred a number of other expenses in 1976, including almost $8,000 in professional (mainly legal) fees and several thousand dollars in advertising, promotion, consulting, office, and insurance expenses. Construction of the shopping center began on March 1, 1977, and was completed on September 1, by which time the partnership had signed leases with a number of tenants. The tenants had made deposits, and even paid some rental, before occupancy on September 1. But after deducting from this income the various fees and expenses that we have mentioned, the partnership reported net losses on its income tax returns for 1976 and 1977, losses which in turn showed up on the partners’ income tax returns.
The Internal Revenue Service disallowed the deductions and assessed deficiencies against the partners, resulting in this litigation. The Tax Court held that the $9,000 brokerage fee paid to secure the standby commitment for the permanent mortgage was a capital expenditure that must be amortized over the life of the mortgage and that the professional fees were nondeductible partnership organizational expenses (see 26 U.S.C. § 709(a)), but that the rest of the fees and expenses were deductible under section 212(2) even though incurred before the shopping center was built and began to operate.
The case is fairly simple once it is located in the right matrix of statutory provisions and tax principles. Until 1942 the only statutory authority for deducting expenses incurred in profit-making activities was the predecessor to section 162, a provision expressly limited to expenses incurred “in carrying on any trade or business.” Individuals who incurred expenses for the production of nonbusiness income — for example, income from passive investments— were out in the cold. That year Congress, in an effort to correct the unequal treatment of business and nonbusiness income, enacted the predecessor to section 212. The legislative history indicates that, other than by relaxing the requirement that the expenses be incurred in the operation of a trade or business, section 212 is not intended to spare individuals who incur expenses for the production of nonbusiness income from any of the “restrictions and limitations that apply in the case of a deduction under” section 162. H.Rep. No. 2333, 77th Cong., 2d Sess. 75 (1942); S.Rep. No. 1631, 77th Cong., 2d Sess. 88 (1942); see
United States v. Gilmore,
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In a long line of decisions under section 162, the courts (including the Tax Court) have held that “pre-opening” expenses, that is, expenses incurred before the taxpayer’s trade or business begins to operate (what we are calling “start-up costs”), are not deductible. See, e.g.,
Madison Gas & Elec. Co. v. Commissioner,
Although the taxpayers in this case thus could not deduct the expenses in question under section 162, the reason has little or nothing to do with the language of the section; as a matter of semantics, some of the expenses of carrying on a trade or business could be incurred before the trade or business went into operation. It has everything to do with the basic principle of tax law that — subject to considerations of expediency discussed in
Encyclopaedia Britannica, Inc. v. Commissioner, supra,
The principle that income and expense must be matched temporally is a limitation on the right to deduct expenses incurred in profit-making (more precisely, profit-seeking) activity, and is logically applicable to start-up costs whether they are incurred by an individual, who can invoke section 212 as well as (if the income is business income) section 162, or by a corporation, which is confined to section 162. And we have seen that Congress intended to preserve all of section 162’s restrictions and limitations in section 212, except the limitation to trades and businesses. So, for example, if a member of this panel rents a safe-deposit box to keep his securities in, he can deduct the annual rental under section 212; but if he buys a safe he must capitalize its purchase price — he can’t just deduct the price from his investment income in the year of the purchase. Otherwise taxpayers would have an incentive unrelated to the efficient use of resources to buy rather than rent safe places for their securities.
*313
This case is trickier than onr example. The Internal Revenue Service is not quarreling with the taxpayers’ deducting the ground rents and other expenses in those months when tenants were occupying the shopping center and paying rent. Just the earlier months are in issue. It is as if the Service were challenging the deduction of a safe-deposit box rental paid for several months before the taxpayer deposited any securities. Yet we know that a taxpayer can deduct as a current expense the costs it incurs to find customers, tenants, etc. — can even deduct the expense of finding a sub-lessee of his house. See
Lord v. Commissioner,
It is true that section 212 does not distinguish explicitly between current expenses and capital expenditures, and does not (as does section 162 via section 161) incorporate section 263 by reference. However, the key word in section 212 — “expenses”— is more commonly associated with current expenses than with capital expenditures. More important, Congress from the beginning wanted section 212 to be interpreted consistently with section 162, as we have seen; and it would be absurd if a partnership that built a shopping center could deduct its start-up costs but a corporation could not. A further clue is section 195, which before the 1984 amendment mentioned earlier allowed both corporations and individuals to amortize start-up costs. The provision would have been pointless as applied to individuals if they could have deducted such costs as current expenses, since that would almost always be preferable from the taxpayer’s standpoint. The 1984 amendment simply made clear, what had previously been assumed, that indeed they could not deduct such costs as current expenses.
Focusing on the ground-lease rentals that the partnership paid before the shopping center was finished and occupied, the taxpayers argue that rental is inherently a current expense. This is true enough if the rental is generating current revenue. Once the shopping center was in operation and throwing off income to the partnership, the rental that the partnership was paying to the owner of the land on which the shopping center had been built was a cost incurred to generate current income. So at least the Internal Revenue Service concedes in this case, making it unnecessary for us to decide whether a 50-year lease with an option to renew for 30 more years plus an option to buy might not be better analyzed as the purchase of a capital asset — the leasehold estate.
Before the shopping center began generating any income to the partnership, the rentals paid to the owner of the land were start-up costs indistinguishable from the expenses incurred in negotiating the lease; they were “advance payments in contemplation of future benefits.”
Southwestern Hotel Co. v. United States,
Regarding the other principal item allowed by the Tax Court, mortgage-commitment fees, the taxpayers argue that the Internal Revenue Service conceded in the Tax Court that those fees are deductible under section 212. That is not correct. Thé Service conceded that if the fees were “otherwise deductible” under section 212 it would not challenge their deductibility on the ground, for example, that they must be amortized over the term of the mortgages, as the Tax Court held with regard to the brokerage fee for the permanent mortgage. The word “otherwise” is a reference to the Tax Court’s belief, which the Service obviously does not share, that start-up costs incurred by individuals are deductible under section 212. There was no concession relevant to this appeal.
In holding that the Tax Court erred in allowing the deduction of ground lease rentals, commitment fees, and other start-up costs, we bypass two questions that might affect the outcome. The first is when the start-up period ceased, that is, when the trade or business, in this case the business of operating a shopping center, began. Such questions arise frequently in cases governed by section 162 alone because the taxpayer is a corporation, see, e.g.,
Blitzer v. United States,
Reversed.