Beware the “Hobby Loss” Rules

Folks engaged in activities that may border on “fun” should always be cognizant of the “hobby loss” rules, pursuant to which IRS may disallow losses which ostensibly arise from the taxpayer’s good times.

In the recent case of John Sernett, the taxpayer was a successful salesperson and also operated a sprint car racing activity, and did so for many years.  During the years under scrutiny, he owned various race cars, a full-sized semitrailer, and owned or leased a shop related to all of this.

Unfortunately, for ten years, he reported losses totaling over $600,000 on his Schedule Cs.  And in looking at his situation, the Tax Court considered the nine factors set forth in Reg 1.183-2(b) in its effort to determine whether the taxpayer actually intended to earn a profit from his car “business”.  The conclusion was that four favored the IRS, two favored the taxpayer, and three were neutral, leading the court to conclude that particularly because the “business” was a mature activity, the history of significant, sustained losses and the taxpayer’s inability to reduce expenses or increase revenue indicated that the taxpayer did not have an actual, honest profit objective, for purposes of applying the IRC Section 83 limitation.