Is it a “Hobby” or “Business”?
Part 4
July 22, 2004
By Jim Harnsberger, Sr. Tax Analyst

SAN DIEGO – The Fourth and Fifth test criteria of the Nine-Point test are important for consideration of the operations of the business. A clear definition with objective standards should be made in answering these two important questions.

The taxpayer's profit objective must be bona fide, taking into account all of the facts and circumstances. See Keanini v . Commissioner, supra at 46; Dreicer v. Commissioner, supra at 645; Golanty v. Commissioner [Dec. 36,111], 72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d 170 (9th Cir. 1981); Bessenyey v. Commissioner [Dec. 27,660], 45 T.C. 261, 274 (1965), affd. [67-2 USTC 9488] 379 F.2d 252 (2d Cir. 1967).

Whether a taxpayer engaged in an activity with an actual and honest objective of realizing a profit must be determined year to year. See Golanty v. Commissioner, supra at 426; sec. 1.183-2(a) and (ii), Income Tax Regs. More weight is given to objective facts than to the taxpayer's statement of intent. See Engdahl v. Commissioner [Dec. 36,167], 72 T.C. 659, 666 (1979); sec. 1.183-2(a), Income Tax Regs.

4. Expectation That Assets May Appreciate
An expectation that assets used in the activity will appreciate in value may indicate a profit objective. Golanty v. Commissioner , 72 T.C. at 427-428; Bessenyey v. Commissioner , 45 T.C. 261, 274 (1965), affd. 379 F.2d 252 (2d Cir. 1967); Hillman v. Commissioner , T.C. Memo. 1999-255; Dodge v. Commissioner , T.C. Memo. 1998-89, affd. 188 F.3d 507 (6th Cir. 1999); sec. 1.183-2(b)(4), Income Tax Regs. A taxpayer may expect, despite the lack of profit from current operations, that an overall profit will result when appreciation in the value of assets used in the activity is realized. Bessenyey v. Commissioner , 45 T.C. 261, 274 (1965), affd. 379 F.2d 252 (2d Cir. 1967); sec. 1.183-2(b)(4), Income Tax Regs. There is an overall profit if future net earnings and appreciation are sufficient to recoup losses sustained in prior years. Bessenyey v. Commissioner, supra.

How “profits” will be defined is important for several reasons. Not the least of which is that profits can be realized in numerous ways beyond traditional beliefs. For example the future appreciated value of the business, its assets, land or other factors may define the “ultimate” profit objectives of the business.

5. Past Success in Similar or Dissimilar Activities
A taxpayer's past success in similar or dissimilar activities may indicate that his engagement in a presently unprofitable activity is for profit. Sec. 1.183-2(b)(5), Income Tax Regs. Within a business plan for the business (strongly recommended for every business), this issue can be addressed in narrative form through the Executive Summary portion of the business plan document.

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