The rule basically says that if an activity makes a profit in three of any consecutive five year period, it will be presumed to be a business in the other two years. Examples of borderline activities would include breeding cats, dogs or other animals, making arts and crafts for sale at craft shows, publishing a newsletter, participating in various kinds of home party selling where your main objective is to get discounts on the products, and other activities where your primary objective is personal satisfaction rather than economic gain. However, if you are engaged in an activity with an intent to make a profit, and if you are prepared to argue with the IRS in the event that they challenge you, then the law does not prohibit you from claiming deductions for losses every year without any restriction on the number of years such losses can be deducted. You do not have to forgo your loss deductions even if you don t have a profit in three of every five years. That profit doesn t have to occur right away.
Some businesses take many years to reach the point where they are able to show a profit.
To demonstrate that your activity is profit motivated, you need to demonstrate that the activity is being operated in a business like manner and that you have a reasonable business plan that will lead to economic success. At a minimum, you should have a name for the business, some stationary, invoices, a separate bank account, separate books and records, a place in your home that is used only for this business activity and some records to show that you are spending some time working on this activity on a regular basis. A daily log or journal would be a substantial help in this regard. It would also help you to be able to show that you are actively studying and learning how to be financially successful in this activity. Your suggestions for improving this web site are welcome.