Is there a three-year limit on showing a loss for a business?

[ASLlearner]

And does Net Operating Loss apply if there is other income that is not business-related?

[Phillip1 · Accepted solution]

There is a 3 out of 5 year rule for the IRS to make a determination as to whether a business has a profit motive. The rule means that a business must show a net profit for 3 out of the first 5 years that the business is in operation or the IRS will make the determination that the business is a hobby. 

If the IRS determines that the business is a hobby, they will change the tax returns that the business has filed under hobby income and expense rules (the income is reported on line 21 of the return, and the expenses are limited to the gross income and they are deducted as a miscellaneous itemized deduction.

This will have an effect on an NOL if the losses that generated the NOL were from the business losses. 

[FR925]

Could you please point me to where exactly the IRS says that it's the FIRST 5 years only (vs. ANY 5 years)?

[JamesG1]

It reads "3 or more taxable years in the period of 5 consecutive taxable years".

26 US Code section 183 (d) Activities not engaged for profit states:

(d) Presumption

If the gross income derived from an activity for 3 or more of the taxable years in the period of 5 consecutive taxable years which ends with the taxable year exceeds the deductions attributable to such activity (determined without regard to whether or not such activity is engaged in for profit), then, unless the Secretary establishes to the contrary, such activity shall be presumed for purposes of this chapter for such taxable year to be an activity engaged in for profit. In the case of an activity which consists in major part of the breeding, training, showing, or racing of horses, the preceding sentence shall be applied by substituting “2” for “3” and “7” for “5”.

@FR925 

[Edited 04/01/2021 9:33 AM PST]