Based on the facts listed in your post, the correct option is option one; file Schedule C reporting the $900 of income and the $1,300 lens purchase.
It is not a red flag to report losses in 3 consecutive years as long as you intended to make a profit (the IRS calls this a profit motive). If the IRS does question the profit motive, you would have to be able to show that you did operate the business as a business and not as a hobby.
To determine if your business is a hobby, the IRS looks at numerous factors, including the following:
- Do you put in the necessary time and effort to turn a profit?
- Have you made a profit in this activity in the past, or can you expect to make one in the future?
- Do you have the necessary knowledge to succeed in this field?
- Do you depend on income from this activity?
- Are your losses beyond your control?
See When the IRS Classifies Your Business as a Hobby
As a side note, you can not just close the business and keep the assets (camera gear, etc.). You will need to sell those assets to a 3rd party or treat them as if they were sold by the business to you at fair market value. This will most likely result in a taxable gain to the business due to depreciation recapture. If that gain results in a net profit to the company, it is highly unlikely that the IRS will consider the activity to be a hobby.
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