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THE PURSUIT OF HAPPINESS AND TAX DEDUCTIONS (Hobby Loss Limitations)


31 January, 2017

THE PURSUIT OF HAPPINESS AND TAX DEDUCTIONS (Hobby Loss Limitations)

“The highest form of bliss is living with a certain degree of folly.”  Desiderious Erasmus

 

Dr. McCoy folded his knife blade and tucked it back in to his pocket as the Montana sun rose above the mountains. Hanging before him was a freshly dressed elk he took just a few hours before.  He warmed his hands over a cup of coffee and then gathered up his gear:  a Browning A-bolt Composite Stalker handed down from his father and a Nikon D7000.

Dr. McCoy's greatest passion is hunting and he takes it all over the world -- from with his own backyard in Louisiana to all parts unknown. And he films everything to preserve each moment and to share his exploits with his friends and family.

Hunting is an expensive hobby and Dr. McCoy is lucky enough to afford it as a physician.  Like most people with an expensive hobby, Dr. McCoy probably spends more money than he should, but he works hard so he can afford to play hard.  He is actually a very skilled outdoorsman -- better than most of the premier guides he employs.

He takes aim. 
And then it occurs to him, since he is good enough to be a guide and less obnoxious than Ted Nugent, he could treat his exploits as a business and deduct about 45% of every gun and guided trip he ever takes. Since he captures everything on film anyway, he could sell his photographs online and to outdoor magazines. There is a market for outdoor photography and who knows -- maybe he could actually make a dollar doing what he loves most.  We should all be so lucky.

 

He pulls the trigger.
Dr. McCoy establishes McCoy Hunting Productions, LLC, a Louisiana limited liability company, and transfers all his hunting and photography equipment to the company. He opens a bank account, obtains a tax identification number, business and occupational licenses and builds a nice website. And then he drops $20,000.00 into the operating account to fund his first "business trip" to Alaska to shoot the elusive caribou - first with his camera then with his trusty Browning.

The footage of his northwest Alaskan arctic adventure is amazing. The pictures and youtube videos that Dr. McCoy posts to the website (mccoyhuntingproductions.com) receive over 1,000 views from family and friends.  Despite the praise, Dr. McCoy didn't actually sell any photographs, so he will actually recognize a loss of $20,000 in his first year of "business."  Fortunately, Dr. McCoy has enough earnings from his sideline business as a physician to fully utilize the loss.

Just wide of the target.
Taxpayers often enjoy their hobby activity more than they do their job. In many cases, they invest a great deal of time and money, and some eventually make their hobby a full- or part-time business activity.

Unfortunately, the IRS has a lot to say when it comes to the business vs. hobby decision. It's not a problem as long as the new business turns a profit. And it may be fine as well if the business produces a loss and the taxpayer enjoys the activity - even better if the loss can offset other income. However, if the business consistently generates losses, the IRS could determine that these losses are actually nondeductible hobby losses.

Many hobby loss issues center on the weekend farmer or rancher. However, the hobby loss rules are applicable to any type of activity in which the taxpayer might engage, including hunting and fishing. In any case, to escape the hobby loss taint and avoid ending up with nondeductible losses, the activity must be conducted with the actual and honest intent of making a profit.

There are generally two ways to avoid the hobby loss rules. The first is to show a profit in at least three out of five consecutive years (two of seven years for activities involving horse racing, breeding, or showing). If the safe harbor is met, the burden of proof for lack of profit motive is shifted to the IRS. The second way is to run the venture in a manner that shows you intend to turn it into a profit-making business rather than operate it as a mere hobby. The IRS regulations themselves state that the hobby loss rules won't apply if the facts and circumstances show that you have a profit-making objective.

Take another shot.
The best way to prove that you have a profit-making objective is to run the new venture in a businesslike manner. Specifically, the IRS and the courts will look to the following factors: how you run the activity; your expertise in the area (and your advisers' expertise); the time and effort you expend in the enterprise; whether there's an expectation that the assets used in the activity will rise in value; your success in carrying on other similar or dissimilar activities; your history of income or loss in the activity; the amount of occasional profits (if any) that are earned; your financial status; and whether the activity involves elements of personal pleasure or recreation.

In determining whether an activity is engaged in for profit, all facts and circumstances with respect to the activity are taken into account. No one factor is determinative. In addition, it is not intended that only the factors described above are to be considered in making the determination, or that a determination is to be made on the basis that the number of factors (whether or not listed) indicating a lack of profit objective exceeds the number of factors indicating a profit objective, or vice versa.

Use an improved cylinder.
Dr. McCoy just returned from an African safari with a hard drive full of photos and a $30,000.00 expense.  It is clear from the results of the Alaskan adventure that he will not turn a profit by just posting photographs and youtube videos on the website.  While we all have a Constitutional right to make bad business decisions, if Dr. McCoy wants to continue deducting expenses of McCoy Hunting Productions, he will need to figure out how to actually make a dollar, or simply accept the fact that he has a very expensive hobby, which he is lucky enough to afford.
“Choose a job you love and you will never 
have to work a day in your life.”  
Confucius
Theus Law Offices provides a complete range of tax planning and litigation services for businesses and individuals. If you are facing a tax issue and need a Louisiana tax attorney in Alexandria, Lafayette, Lake Charles, Baton Rouge, New Orleans, Shreveport, Monroe or elsewhere in Louisiana, let our tax attorneys help you.

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