Listed below are nine factors that the IRS looks at to decide whether an activity is run for profit (even if losses have resulted), or as a hobby. A "yes" answer supports a finding of a profit motive, although no one factor settles the matter.
- How the business is run Is the activity carried on in a businesslike manner? Does the owner keep complete and accurate business records and books? Has the owner changed business methods or operations to increase or improve profits?
- Expertise Does the owner have the necessary expertise to run the business? If not, does he or she seek (and follow) expert advice?
- Time and effort Does the owner spend the time and effort needed for the business to succeed? (Spending a lot of time on the activity will not, however, prove a profit motive if the activity has significant personal or recreational aspects.)
- Appreciation Is it likely that business assets will appreciate in value over time? A profit motive can exist if gain from the eventual sale of assets, plus any other income, would result in an overall profit even if there's no profit from current operations.
- Success with other activities Has the owner engaged in similar (or dissimilar) activities in the past and operated them as profitable enterprises?
- History of income or loss Did the business losses occur because the business was still in a startup phase or because of unforeseen circumstances? If the owner continues the activity despite continuing losses for many years, it may indicate that the activity is a hobby.
- Amounts of occasional profits Are the amounts of occasional profits significant when compared to the size of the owner's investment in the activity, and the amounts of losses suffered in other years? An occasional small profit for an activity generating large losses, or in which the owner has a large investment, will not establish a for-profit objective.
- Financial status of owner Is the business activity the only source of the owner's income?
- Personal pleasure or recreation Is the business of a type that is not usually considered to have elements of personal pleasure or recreation?
Planning to establish a profit motive. How you can go about showing that your activity is operated for profit will depend, in large part, on whether you expect it to profit over either the short run or long run.
- Profit possible over short term by planning when to receive income and when to purchase items that generate deductions, try to maximize your income (and minimize deductions) in at least three years (the "profit" years), and maximize deductions (and minimize income) in the remaining two years (the "loss" years). This may allow you to qualify for the presumption of profit motive.
- Profit possible only over long term if it appears that the business will not be profitable for some years, you won't be able to come within the presumption of profit motive. You'll have to rely on qualifying under the IRS's nine-point inquiry to establish profit motive.
- No possibility of profit face it, what you have here is a hobby. You can try to argue that you qualify under the IRS's nine-point inquiry, but in all likelihood, you'll fail. If you want to continue this activity, you may as well either resign yourself to the limitation on hobby losses, or figure out a way to operate that generates profits.