Hello timmy,

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.

The IRS expects new businesses to incur a loss. It is normal for a business to have a year or two of losses before becoming profitable. But if you cannot meet the 3-out-of-5 year rule (3 years of profits in a 5-year period), then you are really a prime candidate for an IRS audit where you would have to prove your profit motive. You can still prove your 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.

There is no rule on how many years you can actually claim a loss. You just need to keep in mind that the longer you continue to report losses, the more likely it is you will be audited and you need to be prepared to prove your profit motives based on the above factors.

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Thank you timmy