Hobby business in FIRE for tax advantages

[jimmyv65]

What would stop you from "running a business" at a loss based on some hobby you enjoy. I like to weld art, I make some money but spend much more on equipment & supplies. I doubt I will ever get profitable at my welded art. If I went to a convention on welding in Vegas, that could be a business expense and tip my biz into being a loss. f your business ran at a loss, you could use that loss against your investment income on your 1040. I think you are allowed to run a business at a loss for 3 years before the IRS calls it a hobby and doesn't allow the deduction.

You take this too far and it is a tax cheat worthy of penalties, etc. It seems like there is some room in the middle ground to treat a hobby as a business and gain some tax advantages.

Does anyone have any experience along these lines?

 

[REWahoo]

What would stop you from "running a business" at a loss based on some hobby you enjoy.

Short answer: The IRS

To help taxpayers and the IRS decide if an activity is entered into for profit or a hobby, the regulations under Section 183 (the so-called ”hobby loss rules”), provide nine factors, which if answered in the affirmative, are indicative of a business.


1. The manner in which the taxpayer carries on the activity. Do they complete accurate books? Were records used to improve performance?

2. The expertise of the taxpayer or his advisers. Did the taxpayer study the activities business practices? Did they consult with experts?

3. The time and effort expended by the taxpayer in carrying on the activity. Do they devote much of their personal time and effort?

4. The expectation that the assets used in the activity may appreciate in value. Is the plan to generate profits through asset appreciation?

5. The success of the taxpayer in carrying on similar or dissimilar activities. Have they converting them from unprofitable to profitable?

6. The taxpayers history of income or losses with respect to the activity. Has the taxpayer become profitable in a reasonable amount of time?

7. The amount of occasional profits. Even a single year of profits can be a strong indication that an activity is not a hobby.

8. The financial status of the taxpayer. Does the taxpayer have other income sources that are being offset by the losses of the activity?

9. Does the activity lack elements of personal pleasure or recreation? If the activity has large personal elements it is indicative of a hobby.

https://www.forbes.com/sites/anthon...navigating-the-hobby-loss-rules/#7d3de0a34991

 

[OldShooter]

The IRS has aready thought of this. There are rules for hobby businesses, including IIRC a clear intent to make a profit and actually making a profit in 2 out of 5 years. If these tests fail, again IIRC, you can only deduct hobby losses to the extent of hobby income. I'm sure they have a detailed rule book on this.

 

[jimmyv65]

Maybe I should have started with that Forbes list in my post. I've seen that and I've seen the IRS pub.

My point is that those questions really get into the grey of it. There are a lot of judgement calls in that list.

Maybe the better question is does any one have an experience in this area?

 

[Aerides]

If you're talking about "i know it's really a hobby but I can color inside the lines and call it a business" then no, I don't have that experience.

But I do have a real hobby business, full above board, EIN/LLC/DBA, all that good stuff, and yes, profitable. Not hugely, not more than a nice part time side job, but to where I don't have to contort myself to fit inside the rules.

Even so, there are specific things that can and can't be deducted, especially when it comes to travel.

 

[jimmyv65]

If you're talking about "i know it's really a hobby but I can color inside the lines and call it a business" then no, I don't have that experience.

For me, right now, it fits your quote. I can't rule out that I'd get it off the ground to a proper level. I'd like that actually and it is maybe a timing question.

It's pretty clear the IRS doesn't want a half baked hobby as a business. I've had small businesses in the past, so I think I could pass many of the treatments on doing proper books, etc.

I got a laugh at the last one in the list of 9. You can't enjoy your work?

 

[Bamaman]

When it comes to income taxes, I keep a very low profile and simple. And 100% documentable honesty.

 

[jimmyv65]

When it comes to income taxes, I keep a very low profile and simple. And 100% documentable honesty.

It isn't a question of honesty. The rules around it aren't 100% black and white.

 

[W2R]

It isn't a question of honesty. The rules around it aren't 100% black and white.

I guess a judge could figure out where the line is? I have no idea how such issues are resolved.

To me, it's about 1,000,000,000,000,000,000 time easier to just LBYM and watch my spending, look for bargains, and so on, than to take on a giant headache like what you are apparently quite eager to rush into.

In other words, 5 out of 5 responses so far on this thread do not recommend trying to fool with interpreting the IRS rules as you suggest.

 

[jimmyv65]

apparently quite eager to rush into.

Really? I am just asking questions.

I've owned a few businesses in my life. I've enjoyed the activity. Now in ER, I an considering the same, but in a space that I am not as certain of my profitability and at a pace that wouldn't be full on.

 

[Aerides]

I think while none of the questions are purely black and white, in their entirety and on face value, the answers would paint a pretty clear picture of what a layman, or, more importantly, an auditor would consider to be either an obvious business or hobby.

And the more someone is answering "but that could be interpreted....." the more they are going to lose in the face of an audit.

There's a world of difference between an earnest attempt at a business which ultimately doesn't turn a profit, vs. eh I do some side tinkering that occasionally brings in a few bucks offsetting some expenses.

 

[RunningBum]

You started off with:

What would stop you from "running a business" at a loss based on some hobby you enjoy. I like to weld art, I make some money but spend much more on equipment & supplies. I doubt I will ever get profitable ...

and then after some negative responses are at:

I am not as certain of my profitability and at a pace that wouldn't be full on.

Everybody has their own conscience, but it seems clear to me that you are trying to bend the rules to write off some expensive tools for a hobby. You asked, don't get mad when you don't get the answer you want.

 

[joeea]

What would stop you from "running a business" at a loss based on some hobby you enjoy.

You take this too far and it is a tax cheat worthy of penalties, etc. It seems like there is some room in the middle ground to treat a hobby as a business and gain some tax advantages.

There is no IRS rule that allows you to treat a hobby as a business for a while and gain tax advantages. It's either a hobby, or it's a business.

What you are really asking is - has anyone gotten away with doing this in spite of the fact that it isn't permitted?

How lucky do you feel?

 

[brucethebroker]

The IRS has aready thought of this. There are rules for hobby businesses, including IIRC a clear intent to make a profit and actually making a profit in 2 out of 5 years. If these tests fail, again IIRC, you can only deduct hobby losses to the extent of hobby income. I'm sure they have a detailed rule book on this.

Yep. Same story my CPA gave. Better show a profit most years. And IRA SEP can offset most of your profits.....

 

[38Chevy454]

I have a small home-based business that I have run for 11 years. Yes it has nice tax advantages, and yes it does require keeping good records and documentation. No I have not been audited, but don't have anything to hide. I meet the IRS definition for a business. There is nothing wrong with taking all of the potential benefits for taxes that you are entitled to. Just follow the IRS rules.

 

[bobandsherry]

IRS should get after Musk and Tesla. Almost 10 years now and no profit. Guess that's just a hobby too. [emoji16]

 

[CaliKid]

It seems to me if some people do pay you money then it's a business not just a hobby. I would talk to a tax expert but it seems that the IRS might let you have a couple years of a business losing money.

 

[youbet]

IRS should get after Musk and Tesla. Almost 10 years now and no profit. Guess that's just a hobby too. [emoji16]

Are Musk and Tesla using the business losses to offset income on their personal 1040? I don't think so........

 

[ivinsfan]

Really? I am just asking questions.

I've owned a few businesses in my life. I've enjoyed the activity. Now in ER, I an considering the same, but in a space that I am not as certain of my profitability and at a pace that wouldn't be full on.

If you have owned a few businesses you are not a novice and should have a tax person. Why don't you ask them what you need to do...

 

[mountainsoft]

What would stop you from "running a business" at a loss based on some hobby you enjoy. I like to weld art, I make some money but spend much more on equipment & supplies. I doubt I will ever get profitable at my welded art. If I went to a convention on welding in Vegas, that could be a business expense and tip my biz into being a loss.

Regardless of the legal rules, that's just bad financial planning. I run a small home based business and earn a small profit. If I didn't have enough profit to cover the cost of the convention, I simply wouldn't go to the convention. Sure, things happen where you "think" the expense is covered then things change to make it a loss (such as a bunch of returns). That's OK once, but if it becomes a habit you're no longer a profitable business.

Enjoy the hobby, attend conventions at your own expense, and don't call it a business until you become profitable.

"Is it a Business or a Hobby? A key feature of a business is that people do it to make a profit."

Generally, taxpayers can only deduct hobby expenses up to the amount of hobby income.

https://www.irs.gov/newsroom/hobby-or-business-irs-offers-tips-to-decide