No Effort To Improve = Lost Deduction

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Three years ago, I’d have said the best way to reduce your taxes was with real estate investing. AMT (alternative minimum tax) is now eroding the tax benefits of real estate. There is one place that still gets huge breaks, though – BUSINESS!

You can take 100% of a business loss against your income – no matter how much you make or how much your business loses. (And remember these can be paper losses.) There is one trick though – you have to qualify as a business.

What does it mean to be a business? In a recent Tax Court ruling, the IRS did not allow a computer specialist (and wannabe basketball coach) to take a loss for his basketball school.

Here’s what they had to say:

The taxpayer did not operate the school in a businesslike manner and he admitted that his principal goal was to land a job with an athletic apparel company. Although he was knowledgeable about the business of basketball, he had no expertise or background in operating a basketball school and he did not seek out expert advice. The school never earned a profit and he testified that he knew he would have to continue to invest large amounts of time and money in operating the school. The school’s losses also offset some of his considerable income from other sources. Accordingly, his deductible losses were limited to his income from the school.

There are 9 factors that the IRS looks for when determing whether a venture is a non-deductible hobby or a deductible business. Let’s see what the computer guy above couldn’t prove:

  1. Run in a business like manner. Nope – looks like he didn’t have a good system for accounting and record-keeping.
  2. Expertise in the business venture. Nope. He had never done this before.
  3. Seek out expert advise or mentors. Nope. If you don’t have the past experience, you can still pass the above point by getting an expert on your team. He didn’t do that.
  4. Goal to create a business. Nope. He wanted to get a job and was using the school in some way to prove he was a viable candidate for the job.

That’s just 4 of the 9 points, but that was enough for the taxpayer to lose the business deduction.

How does your business stack up?

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