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Tax Court: No Hobby Loss Limits for Inherited Hobby Shop.

(Parker Tax Publishing March 9, 2015)

The Tax Court held that just because a taxpayer operated a hobby shop did not mean it was a hobby for her, and allowed business expenses stemming from the model airplane shop she inherited from her father. Savello v. Comm'r, T.C. Memo. 2015-24 (2/12/15).

Background

Cheryl R. Savello worked as an art teacher in Nevada from 2002 until she retired in 2014. In 2006, Savello inherited Aero-tronics Model Supply Co. (Aero-tronics), a model airplane hobby shop in Idaho, from her father who had started the business. Prior to his death, Savello's father operated the business on a daily basis with the help of an unpaid retired individual.

After her father's death, Savello took over Aero-tronics, and retained the volunteer to oversee the day-to-day operations of the store. She would assist with sales when she was in Idaho and eventually moved to Idaho to spend more time working at Aero-tronics and building the business. When she was not in Idaho, her major involvement in the business was signing checks. The store was a traditional brick and mortar business and kept regular store hours.

On Savello's 2010 and 2011 returns, she deducted business losses of $5,540 and $2,628, respectively. The IRS assessed a deficiency, determining that she did not operate Aero-tronics as a trade or business within the meaning of Code Sec. 162, and disallowed the portion of Savello's business expense deductions exceeding the business's income.

Analysis

To be entitled to business deductions under Code Sec. 162(a), taxpayers must show that they engaged in the activity with an objective of making a profit (Code Sec. 183(a)). Under Reg. Sec. 1.183-2(a), losses are not allowable for an activity a taxpayer carries on primarily for sport, as a hobby, or for recreation. Reg. Sec. 1.183-2(b) provides a nonexclusive list of nine factors relevant in ascertaining whether a taxpayer conducts an activity with the intent to earn a profit. The factors listed are:

(1) the way the taxpayer conducts the activity;

(2) expertise of the taxpayer or his advisers;

(3) time and effort the taxpayer spends in carrying on the activity;

(4) expectation that assets used in the activity may appreciate in value;

(5) taxpayer's success in carrying on other similar or dissimilar activities;

(6) taxpayer's history of income or losses with respect to the activity;

(7) amount of occasional profits earned, if any; (8) taxpayer's financial status; and

(9) elements of personal pleasure or recreation.

The Tax Court found that the factors almost universally favored finding a profit motive, and no factor indicated that Savello operated the shop as a hobby. The court determined that, under factor (1), the store was run in a manner substantially similar to other similar profitable businesses. The store was detached, had its own utilities accounts, and had inventory, cash registers, a telephone and display cases. The store also contained office supplies, was open during regular business hours, and had a website under development intended to spur on sales.

Although Savello did not possess expert knowledge on how to build model planes, the court determined that factor (2) still worked in her favor because she had retail experience and retained the knowledgeable volunteer who had worked with her father. Factor (3) also favored finding for Savello. Noting the ability for taxpayers to engage in more than one trade or business simultaneously, the court found the fact that Savello devoted a limited amount of time to the hobby shop did not indicate a lack of profit motive because she retained the competent volunteer to oversee the daily functions of the store. The court also noted that Savello provided assistance with sales when visiting Idaho and the fact she moved to Idaho to focus on building Aero-tronics.

In evaluating factors (6) and (7), the court found that Savello's history of income or losses with respect to the store, and the amount of her occasional profits, did not negatively impact her assertion that she carried on the business for profit. Savello testified about her desire for profitability and testified that the business had broken even, or close to it, in recent years, and may have been profitable for some of the years that her father ran the business. Additionally, the court viewed factor (8) as favorable for Savello's case as she received only a modest income from her position as an art teacher. Finally, the court believed factor (9) strongly helped Savello's claims, as she was not a plane hobbyist like her father and her enjoyment of running the business was not significant enough to be classified as a hobby.

As the factors almost universally favored finding for Savello, the court concluded that she operated Aero-tronics with an objective of making a profit. Despite what the IRS seemed to think, operating a hobby shop is not in itself a hobby. Accordingly, the Court ruled that Savello was entitled to deduct the claimed business expenses that she reported for 2010 and 2011.

For a discussion of the hobby loss rules, see Parker Tax ¶97,505. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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