Presumption of Profit Motive
Below, discover how the IRS defines presumption of profit motive in regard to taxpayers' activities.
There is a presumption that a taxpayer has a profit motive if an activity shows a profit for any three or more years during a period of five consecutive years. However, if the activity involves breeding, training, showing or racing horses, the period is two out of seven consecutive years. (Reg Sec 1.183-1)
Election to Delay Determination of Profit Intent
A taxpayer may elect to get an IRS determination of whether an activity is for profit if the determination is requested before the end of the fourth tax year (sixth year for horse activities) following the year the taxpayer first engages in the activity. In effect, the election suspends the application of the presumption until the taxpayer has a chance to prove himself/herself in the activity. The election can be made within three years of the unextended due date of the return for the year the taxpayer first engaged in the activity. However, it can’t be made later than 60 days after the taxpayer receives a written notice from the IRS that proposes to disallow deductions attributable to a not-for-profit activity.
To make the election, file Form 5213, Election to Postpone Determination as To Whether the Presumption That an Activity is Engaged in for Profit Applies. This form is not filed with a taxpayer’s tax return but is filed separately with the IRS Service Centre where the taxpayer normally files a return or with the office that sent a disallowance of deductions notice if applicable. The election automatically extends the statute of limitations until two years after the date for filing the return for the last year of the presumption period. This extension applies only to the activity for which the taxpayer has made the election.
HOBBY LOSS OR NOT FOR PROFIT LOSS
The question sometimes arises what is the difference between a “hobby loss” and “not for profit determination”? In actuality, they end up being treated the same for income tax purposes. The hobbyist does what he does because he enjoys doing it, didn’t do it with the goal of making a profit and maybe gets a little income from it. Someone who thinks they are in a trade or business but doesn’t conduct the activity in a business-like way and ends up with a loss may find the IRS making the determination the taxpayer wasn’t in it to make a profit after all.