Having your activity qualify as a business can be very beneficial during tax time for you and on the flip side the limitations of it not qualifying can be costly.
Here are 7 steps the IRS has established in order for you to make the determination of whether your activity qualifies as a business or a hobby.
Are your intentions to make a profit? The IRS presumes that if an activity makes a profit for at least 3 of the last 5 tax years (including the current tax year) that the intention is to make a profit, thus qualifying the activity as a business. Remember Net Income – Net Expenses= Net Profit/Loss. For example: If you had income of $5,000 from your activity but the amount of expenses you incurred are $6,000, that will give you a Net Loss of $-1,000 (5,000-6000).
Do you depend on income from the activity?
Have you experienced any losses and if so were they beyond your control or did they occur in the start-up phase of your business?
Have you changed methods of operation to improve profitability? Have you but an unprofitable product or service or have you targeted a new customer base. These are some ways to improve profitability in your business
Do you or your advisors have the knowledge to carry on activity as a successful business. Have you made a similar profit in similar activities in the past?
Does the activity make a profit in some years (at least 3 out of 5 or 2 out of 7 for breeding, showing, training and racing horses)?
Can you expect to make a profit in the future from the appreciation of assets used in the activity? Appreciating assets are assets that go up in value in time. Examples of these are Land, property, or Unique items. Not to be confused with Cars unless of course it is an antique model.