Final answer:
Costs paid for refurbishment activities before placing a building into service can typically be deducted as repairs and maintenance expenses for tax purposes. To assess profitability, one must consider both explicit and implicit costs, with explicit costs being direct monetary expenses and implicit costs representing opportunity costs.
Step-by-step explanation:
The treatment of costs incurred by M for refinishing wood floors, patching holes in walls, and painting the interiors and exteriors of a business building before it is put into service depends on the nature of the expenses. Since none of this work in Year 1 constitutes an improvement to the building or its structural components, these costs may be deducted as repairs and maintenance expenses when the building is placed in service in Year 2. Such expenses must be ordinary, necessary, and directly tied to the business activity to be deductible.
To understand the concept of profitability, we can look at a separate example. Take Fred, who contemplates starting his own legal practice. He calculates his explicit costs, which are the clear, direct costs such as office rent for $50,000 per year and a law clerk's salary of $35,000 per year, totaling $85,000. Provided Fred's projected revenue is $200,000, we would subtract the explicit costs from his expected revenue to get accounting profit, which would be positive in this situation. However, to determine whether or not the business is economically successful, we'd also need to consider implicit costs. Implicit costs are the opportunity costs of using resources that could have been employed elsewhere, like Fred's potential earnings if he continued working at the corporate law firm.