If a business reports a net profit in at least 3 out of 5 years, it is presumed to be a for-profit business. If a business reports a net loss in more than 2 out of 5 years, it is presumed to be a not-for-profit hobby. At that point, the IRS
will likely discontinue your deductions
for a business loss unless you can prove that you truly have a profit motive using the following nine factors:
1. You carry on the activity in a businesslike manner,
2. The time and effort you put into the activity indicate you intend to make it profitable,
3. You depend on income
from the activity for your livelihood,
4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
5. You change your methods of operation in an attempt to improve profitability,
6. You, or your advisors, have the knowledge needed to carry on the activity as a successful business,
7. You were successful in making a profit in similar activities in the past,
8. The activity makes a profit in some years, and how much profit it makes, and
9. You can expect to make a future profit from the appreciation of the assets
used in the activity.
If you can prove to the IRS that at least some of these factors apply, then they may allow you to continue taking losses without applying the 3 out of 5 year rule.
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