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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:
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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