Hi and welcome back to the tax implications podcast.

I’m Sam Hicks, I'm a CPA and tax advisor and

This is your short form podcast covering the items that affect your bottom line

Thank you for tuning in. Today I’ll be discussing hobby loss rules.

Like many, you've probably dreamed of turning a hobby into a regular business. You won't have any unusual tax headaches if your new business is profitable. However, if the new enterprise consistently generates losses (deductions exceed income), IRS may step in and say it's a hobby—the IRS considers these an activity not engaged in for profit—rather than a business.

What are the practical consequences of an activity being treated as a “hobby”?

There are two ways to avoid the hobby loss rules presumption. The first way is to show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses). The second way is to run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. The IRS regs themselves say that the hobby loss rules won't apply if the facts and circumstances show that you have a profit-making objective.

How can you prove that you have a profit-making objective? In general, you can do so by running the new venture in a businesslike manner. More specifically, IRS and the courts will look to the following factors:

how you run the activity;

your expertise in the area (and your advisers' expertise);

the time and effort you expend in the enterprise;

whether there's an expectation that the assets used in the activity will rise in value;

your success in carrying on other similar or dissimilar activities;

your history of income or loss in the activity;

the amount of occasional profits (if any) that are earned;

your financial status;

and whether the activity involves elements of personal pleasure or recreation.

The classic “hobby loss” situation involves a successful businessperson or professional who starts something like a dog-breeding business, or a farm. But IRS's long arm also can reach out to more usual situations, such as businesspeople who start what appears to be a bona-fide sideline business.

You should consult with experienced tax and legal professionals before making any decisions for your business.

Thank you for listening.

If you have any questions that you’d like discussed on a future episode please contact me at [email protected].