Nine-Step Profit Motive Test
Listed below are nine factors that the IRS looks at to decide whether an
activity is run for profit (even if losses have resulted), or as a hobby. A
"yes" answer supports a finding of a profit motive, although no one
factor settles the matter.
- How the business is run - is the activity carried on in a
businesslike manner? Does the owner keep complete and accurate business
records and books? Has the owner changed business operations to increase
- Expertise - does the owner have the necessary expertise to run the
business? If not, does he or she seek (and follow) expert advice?
- Time and effort - does the owner spend the time and effort needed
for the business to succeed? (Spending a lot of time on the activity will
not, however, prove a profit motive if the activity has significant personal
or recreational aspects.)
- Appreciation - is it likely that business assets will appreciate in
value over time? A profit motive can exist if gain from the eventual sale of
assets, plus any other income, would result in an overall profit even if
there's no profit from current operations.
- Success with other activities - has the owner engaged in similar
(or dissimilar) activities in the past and converted them from unprofitable
to profitable enterprises?
- History of income or loss - did the business losses occur because
the business was still in a startup phase, or because of unforeseen
circumstances? If the owner continues the activity despite continuing losses
for many years it may indicate that the activity is a hobby.
- Amounts of occasional profits - are the amounts of occasional
profits significant when compared to the size of the owner's investment in
the activity, and the amounts of losses suffered in other years? An
occasional small profit for an activity generating large losses, or in which
the owner has a large investment, will not establish a for-profit objective.
- Financial status of owner - is the business activity the only
source of the owner's income?
- Personal pleasure or recreation - is the business of a type that is
not usually considered to have elements of personal pleasure or recreation?
Planning to establish a profit motive. How you can go about showing
that your activity is operated for profit will depend, in large part, on whether
you expect it to profit over either the short run or long run.
- Profit possible over short term - by planning when to receive
income and when to purchase items that generate deductions, try to maximize
your income (and minimize deductions) in at least three years (the
"profit" years), and maximize deductions (and minimize income) in
the remaining two years (the "loss" years). This may allow you to
qualify for the presumption
of profit motive.
- Profit possible only over long term - if it appears that the
business will not be profitable for some years, you won't be able to come
within the presumption of profit motive. You'll have to rely on qualifying
under the IRS's nine-point inquiry to establish profit motive.
- No possibility of profit - face it: what you have here is a hobby.
You can try to argue that you qualify under the IRS's nine-point inquiry,
but in all likelihood you'll fail. If you want to continue this activity,
you may as well either resign yourself to the limitation on hobby losses, or
figure out a way to operate that generates profits.