“ How do we deduct the start up costs and will this be considered a net loss for the business since there were expenses but no income?”---->The start up rules apply to two kinds of start-up expenses,i.e., analyses and surveys of potential markets, products, labor supply, transportation facilities and the like. Or advertisements announcing the business opening or etc.However, your start-up costs do not include any costs that are otherwise deductible on the business’s tax return, such as interest, taxes any money spent investigating whether to create or acquire a new business, and all business expenses incurred before opening day in order to get the business started. The IRS says, for example, that start-up costs include:the amount that can be deducted in the first year is $5,000 or the actual amount of the start-up costs, whichever is less. However, the deduction is reduced by the amount by which total start-up costs exceed $50,000 total (including expenditures incurred before Oct. 22, 2004). Any amount not written off in the first year can be deducted over 180 months, starting in the month after the business begins.
Please visit the IRS website here; Publication 535 (2009), Business Expenses
“He purchased approximately $4-5K in machines, tools, parts, website, etc. in 2010 but did not receive any income as he hadn't finished the guitars at that time.”---->So, if your deductions are more than your income for the year( I mean when your business' expenses including deprecition expenses of machines, tools, or etc. are in excess of its income), you may have a net operating loss. You can use a net operating loss to lower your taxes in other years. As a individual, your NOL is not the same as negative taxable income onForm 1040. I n fact, your NOL is computed on Form 1045 , Sch A for a refund of prior year income taxes. Once computed, your NOL generated in 2010 is carried back two years, and then carried forward 20 years. Alternatively you can elect to forgo the carryback and carry forward your NOL for 20 years.
Please visit the website here; Publication 535 (2009), Business Expenses