Frequently, taxpayers will try to turn a personal pursuit into a legitimate business operation, enabling them to deduct expenses in excess of the income produced by the activity. It doesn’t matter if the undertaking is extraordinary or unusual. But you must at least try to turn a profit or your deductions will be limited to the income produced by the activity under the hobby loss rule found in Section 183 of the Internal Revenue Code.
New decision: The IRS assessed tax deficiencies of around $4 million against a taxpayer who spent a small fortune investigating the cause of his father’s death. Although the authorities had labeled the death a suicide, the taxpayer received an anonymous letter stating that his father had been murdered. He then engaged in a decade-long crusade to get to the bottom of the matter. Along the way, he claimed his priorities had changed.
According to court documents, the taxpayer asserted that he eventually viewed the letter as a means to various business opportunities. He envisioned it resulting in a book and movie adaptation and related revenue. To this end, he established partnerships that paid for private investigators, as well as commissioning a writer to draft a manuscript.
The case turned on whether the taxpayer could establish that he was engaged in these activities to turn a profit. In arriving at its decision, the courts examined the following nine factors set forth in the prevailing regulations:
1. The manner in which the taxpayer carries on the activity
2. The expertise of the taxpayer or his or her advisors
3. The time and effort expended by the taxpayer in carrying on the activity
4. Any expectation that assets used in activity may appreciate in value
5. The success of the taxpayer in carrying on other similar or dissimilar activities
6. The taxpayer’s history of income or losses with respect to the activity
7. The amount of occasional profits, if any, which are earned
8. The financial status of the taxpayer
9. Any elements of personal pleasure or recreation.
Affirming the district court’s decision, the Fifth Circuit Court found that there was no profit motive. It referred to the lack of annual profits, the lack of a business plan and the taxpayer’s personal lack of expertise in the matter. Thus, the deductions were denied under the hobby loss rule. (Vest, CA-5, 6/2/17)