Mark J. Kohler explains the IRS hobby-loss rule: the agency presumes your business is a hobby unless you show profit in three of the last five years. You can lose money in years one and two, but by year three you need to break even or profit. Rental real-estate losses don't count against this rule.
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Hi, Mark Kohler here with a two minute tax and legal tip and I want to talk about the hobby loss rules. Now this is an important one for any small business owner and frankly, I think there's been a lot of fear generated about this topic over the years and maybe with some accounts that are overly conservative, but I think it's something that does need to be talked about and every small business owner should know what the rules are. So I want to make three important points that's going to save you from getting a nasty letter from the irs. Number one, what is the hobby loss rule? Well, essentially what the IRS has said is that you have to show profit in your business three out of five years. So for the first two years you can lose money, which is okay, but by the third year you better show profit. If not, the IRS is going to make a presumption and ask, why do you keep running this business? If you're losing money, either you really suck at it or it must be a hobby or no person in their right mind will keep running this business. Well, that's what the question is and that's why a letter from the IRS might be generated asking about your losses. So number two, the question is, should you worry about this? Well, I think you should, but not stress about it. In the third year after losing money for a couple years, you and your accountant should sit down and go, well, maybe we should tone down some of these expenses. Just show us break even. And I know some of you out there, you know, hammered out on TurboTax, want those deductions because you want to, you know, reduce your other income and generate some sort of tax savings or tax refund. But you want to be cautious in that third year. Show break even. Even. Don't get too aggressive. Remember, pigs get fat and hogs get slaughtered. Number three, keep in mind that rental losses do not apply to rental real estate. Rental property is exempt from the hobby loss rule because you're going to be buying rental real estate that's growing in value and generating tax free cash flow. But those losses are going to flow through and generate major tax savings either immediately or in the future. But hobby losses don't apply. You're not going to get a nasty letter from the irs. You because you have rental property losses. So don't stress and keep buying those rental properties. So bottom line, I want to recommend this, and that is make sure you are always interested in starting a small business. Take the effort to start a small business, even report those losses the first or second year and don't be afraid of having losses on your tax return. It's very normal to start a small business and lose money the first year or two. It's okay, don't be afraid of that hobby loss, but make sure in that third year again you're toning it down and not getting too aggressive. Small business ownership is the fastest way to building long term wealth extra income and helping you generate that freedom or flexibility to better live your American Dream. Be aware of the hobby loss rules, but don't be afraid to live your American dream. Thanks for listening and I hope that information was helpful and let me speak from the heart here. I've been talking about topics like this for 1015 years. I'm a CPA attorney, best selling author, radio show host and I passionate about helping small business owners save taxes, build wealth and protect it. Please check out the link right here. Download my free ebook on 10 Common Mistakes Small business owners make in the tax and legal arena. Also check out my social media links here. I've got Daily Tips, a weekly blog radio show every week. This information is free and I'd love to help you. Click below. Find out more about me and thanks for listening. Sam.
