Hobby Loss Considerations
The IRS could consider your business loss to be a "hobby loss". A hobby loss results from an activity that is not profit motivated. If the IRS prevails, your business deductions for the year will be limited to your business
income reducing your loss to zero. Further, the IRS could go back to previous years and reduce similar losses.
Therefore, be sure to conduct this activity as a reasonable business person (i.e. document your investigation into the profitability of the activity, have a business plan, keep good records, etc.). Normally, if a business is not profitable within a few years, a reasonable person would discontinue the activity. Generally, the IRS presumes a profit motive exists, if the business shows a profit in 3 out of 5 years (some specific industries have different timelines). However, the profit shown must be significant in relation to the loss period (i.e. reporting losses for 2 years equal $10,000 and profits for 3 years of $300 will probably not satisfy the profit motive test). In addition, we have noted during audits that the IRS looks to see if there is any enjoyable aspect to the business. If the business involves horses, racing, making jewelry or some other craft, they are more likely to question a loss.