THE classic “hobby loss” situation involves a professional or businessperson who starts Zumba classes, dog-breeding business or a farm. If the IRS determines that the Zumba, dog-breeding, or farm project is more for enjoyment rather than making money, it could be classified as a hobby. Losses from hobbies are not deductible.
A sole proprietor who files Schedule C losses for three years or more could encourage an auditor to request proof that you are actually in business to make money.
Here are 10 items that IRS looks for:
• Whether you run your new venture in a businesslike manner.
• Your expertise in the area.
• The expertise of your advisers.
• The time and effort you spend 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.
• Whether the activity involves elements of personal pleasure or recreation.
Tip – consider filing Form 5213 – Election to postpone determination if hobby is engaged for profit:
Form 5213 basically tells the IRS not to audit you for the first five years of your business. This form is used to establish a safe harbor as you transition hobby into a money-making business endeavor. But once that five-year window closes, you draw attention to results of your operations – have you finally made money?
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Victor Santos Sy graduated Cum Laude from UE with a BBA and from Indiana State University with an MBA. Vic worked with SyCip, Gorres, Velayo (SGV – Andersen Consulting) and Ernst & Young before establishing Sy Accountancy Corporation in Pasadena, California.
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He has 50 years of experience in defending taxpayers audited by the IRS, FTB, EDD, BOE and other governmental agencies. He is publishing a book on his expertise – “HOW TO AVOID OR SURVIVE IRS AUDITS.” Our readers may inquire about the book or email tax questions at firstname.lastname@example.org.