BBS Toolkit/BBS Toolkit.iso/programs/bbslaw10.zip/183.STA

Text File | 1993-03-21 | 50KB | 999 lines

/* Section 1.183-1 of the Regulations of the Internal Revenue
Service, regarding disallowance of hobby losses follows, with our
sterling and decisive comments which explain the law. */

Section 1.183-1 Activities not engaged in for profit.

(a) In general. Section 183 provides rules relating to the
allowance of deductions in the case of activities (whether active
or passive in character) not engaged in for profit by individuals
and electing small business corporations, creates a presumption
that an activity is engaged in for profit if certain requirements
are met, and permits the taxpayer to elect to postpone
determination of whether such presumption applies until he has
engaged in the activity for at least 5 taxable years, or, in
certain cases, 7 taxable years. Whether an activity is engaged in
for profit is determined under section 162 and section 212(1) and
(2) except insofar as certain as section 183(d) creates a
presumption that the activity is engaged in for profit. If
deductions are not allowable under sections 162 and 212(1) and
(2), the deduction allowance rules of section 183(b) and this
section apply. Pursuant to section 641(b), the taxable income of
an estate or trust is computer in the same manner as in the case
of an individual, with certain exceptions not here relevant.
Accordingly, where an estate or trust engages in an activity or
activities which are not for profit, the rules of section 183 and
this section apply in computing the allowable deductions of such
trust or estate. No inference is to be drawn from the provisions
of section 183 and the regulations thereunder that any activity
of a corporation (other than an electing small business
corporation) is or is not a business or engaged in for profit.
For rules relating to the deductions that may be taken into
account by taxable membership organizations which are operate
primarily to furnish services, facilities, or goods to members,
see section 277 and the regulations thereunder. For the
definitions of an activity not engaged in for profit, see
1-183-2. For rules relating to the election contained in section
183(e), see section 1.183-3.

(b) Deductions allowable-- (1) Manner and extent. If an activity
is not engaged in for profit, deductions are allowable under
section 183(b) in the following order and only to the following
extent:

(i) Amounts allowable as deductions during the taxable year under
chapter 1 of the Code without regard to whether the activity
gives rise to such amounts was engaged in for profit are
allowable to the full extent allowed by the relevant sections of
the Code, determined after taking into account any limitations or
exceptions with respect to the allowability of such amounts. For
example  the allowability-of-interest expenses incurred with
respect to activities not engaged in for profit is limited by the
rules contain in section 163(d).

(ii) Amounts otherwise allowable as deductions during the taxable
year under chapter 1 of the Code, but only if such allowance
does not result in an adjustment to the basis of property,
determined as if the activity giving rise to such amounts was
engaged in for profit, are allowed only to the extent the gross
income attributable to such activity exceeds the gross income
attributable to such activity exceeds the deductions allowed or
allowable under subdivision (i) of this subparagraph.

(iii) Amounts otherwise allowable as deductions for the taxable
year under Chapter 1 of the Code which result in (or if otherwise
allowed would have resulted in) an adjustment to the basis of
property, determined as if the activity giving rise to such
deductions was engaged in for profit, are allowed only to the
extent the gross income attributable to such activity exceeds the
deductions allowed or allowable under subdivisions (i) and (ii)
of this subparagraph. Deductions falling within this subdivision
include such items as depreciation, partial losses with respect
to property, partially worthless debts, amortization, and
amortizable bond premium.

(2) Rule for deductions involving basis adjustments-- (i) In
general. If deductions are allowable under subparagraph (1)(iii)
of this paragraph, and such deductions are allowed with respect
to more than one asset, the deduction allowed with respect to each
asset shall be determiners separately in accordance with the
computation set forth in subdivision (ii) of this subparagraph.

(ii) Basis adjustment fraction. The deduction allowed under
subparagraph (1)(iii) of this paragraph is computer by multiplying
the amount which would have been allowed, had the activity been
engaged in for profit, as a deduction with respect to each
particular asset which involves a basis adjustment, by the basis
adjustment fraction--

(a) The numerator of which is the total of deductions allowable
under subparagraph (1)(iii) of this paragraph, and

(b) The denominator of which is the total of deductions which
involve basis adjustment which would have been allowed with
respect to the activities had the activity had the activity been
engaged in for profit.

The amount resulting from this computation is the deduction
allowed under subparagraph (1)(iii) of this paragraph with
respect to the particular asset. The basis of such asset is
adjusted only to the extent of such deduction.

(3) Examples. The provisions of subparagraphs (1) and (2) of this
paragraph may be illustrated by the following examples:

Example (1). A, an individual, maintains a herd of dairy cattle,
which is an "activity not engaged in for profit" within the
meaning of section 183(c). A sold milk for $ 1,000 during the
year. During the year the year A paid $ 300 State taxes on
gasoline used to transport the cows, milk, etc., and paid $ 1,200
for feed for the cows. For the year A also had a casualty loss
attributable to this activity of $ 500. A determines the amount
of his allowable deductions under section 183 as follows:

(i) First, A computes his deductions allowable under subparagraph
(1)(i) of this paragraph as follows:

State gasoline taxes specifically allowed under section 164(a)(5)
without regard to whether the activity is engaged in for profit

                                       ........... $ 300


Casualty loss specifically allowed under section 165(c)(3)
without regard to whether the activity is engaged in for profit
($ 500 less $ 100 limitation)

                                       ........... $ 400


Deductions allowable under subparagraph (1)(i) of this paragraph

                                       ........... $ 700


(ii) Second. A computes his deductions allowable under
subparagraph (deductions which would be allowed under Chapter 1
of the Code if the activity were engaged in for profit and which
do not involve basis adjustment) as follows:

Maximum amount of deductions allowable under subparagraph (1)(ii)
of this paragraph:


Income from milk sales                 .......... $ 1,000
                                       __________________

Gross income from activity             .......... $ 1,000

Less: deductions allowable
under subparagraph (1)(ii)
of this paragraph                                     700
                                       __________________

Maximum amount of
deductions allowable under
subparagraph                                           300
                                       __________________


Feed for cows                                       1,200


Deduction allowed under
subparagraph (1)(ii) of
this paragraph                                        300

$ 900 of the feed expense is not allowed as a deduction under
section 183 because the total feed expense ($ 1,200), exceeds the
maximum amount of deductions allowable under subparagraph (1)(ii)
of this paragraph ($300). In view of these circumstances, it is
not necessary to determine deductions allowable under subparagraph
(1)(iii) of this paragraph which would be allowable under chapter
1 of the Code if the activity were engaged in for profit and
which involve basis adjustment (the $ 100 of casualty loss not
allowable under subparagraph (1)(i) of this paragraph because of
the limitation in section 165(c)(3)) because none of such amount
will be allowed as a deduction under section 183.

Example (2). Assume the same facts in example (1), except that A
also had income from sales of hay grown on the farm of $ 1,200
and that depreciation of $ 750 with respect to a barn, and $ 650
with respect to the activity had it been engaged in for profit. A
determines the amount of his allowable deductions under section
183 as follows:

(i) First, A computes his deductions allowable under
subparagraph (1)(i) of this paragraph as follows:

State gasoline taxes
specifically allowed
under section 164(a)(5)
without regard to whether
the activity is engaged in
for profit                             .......... $  300


Casualty loss specifically
allowed under section
165(c)(3) without regard
to whether the activity is
engaged in for profit ($ 500
less $ 100 limitation)                 ..........    400
                                       _________________


Deductions allowable under
subparagraph (1)(i)
of this paragraph                      ..........    700


(ii) Second, A computes his deductions allowable under
subparagraph (1)(ii) of this paragraph (deductions which would be
allowed under chapter 1 of the Code if the activity were engaged
in for profit and which do not involve basis adjustment) as
follows:

Maximum amount of deductions allowable under subparagraph (1)(ii)
of this paragraph:


Income for milk sales                  .......... $ 1,000
                                       __________________

Income from hay sales                  ..........   1,200
                                       __________________

Gross income from
activity                               ..........   2,200
                                       __________________

Less: deductions
allowable under
subparagraph (1)(i)
of this paragraph                      ..........     700
                                       __________________

Maximum amount of
deductions allowable
under subparagraph (1)(ii)
of this paragraph                       ..........   1,500
                                       ___________________


Feed for cows                                       1,200

The entire $ 1,200 of expenses relating to feed for cows is
allowable as a deduction under subparagraph (1)(ii) of this
subparagraph, since it does not exceed the maximum amount of
deductions allowable under such subparagraph.


(iii) Last, A computes the deductions allowable under
subparagraph (1)(iii) of this paragraph:

Gross income from farming              .......... $ 2,200

Less: Deductions allowed
under subparagraph (1)(i)
of this paragraph                $ 700

Deductions allowed under
subparagraph (1)(ii) of this
paragraph                         1200              1,900
                            __________ ___________________


Maximum amount of
deductions allowable
under subparagraph (1)
(iii) of this paragraph                ..........     300


(iv) Since the total of A's deductions under Chapter 1 of the
Code (determined as if the activity was engaged in for profit)
which involve basis adjustments ($ 750 with respect to the barn,
$ 650 with respect to tractor, and $ 100 with respect to
limitation on casualty loss) exceeds the maximum amount of the
deductions allowable under subparagraph (1)(iii) of this
paragraph ($ 300). A computes his allowable deductions with
respect to such assets as follows:

A first computes his basis adjustment fraction under subparagraph
(2)(ii) of this paragraph as follows:

The numerator of the fraction
is the maximum of deductions
allowable under subparagraph
(1)(iii) of this paragraph which
involve basis adjustments              ..........  $   300


The denominator of the fraction
is the total of deductions that
involve basis adjustments which
would have been allowed with
respect to the activity had the
activity been engaged in
for profit                             .......... $  1,500

The basis adjustment fraction is then applied to the amount of
each deduction which would have been allowable if the activity
were engaged in for profit and which involve a basis adjustment
as follows:

Depreciation allowed with
respect to barn (300/
1,500 x 750)                           .......... $    150

Depreciation allowed with
respect to tractor                     ..........      130

Deduction allowed with
respect to limitation on
casualty loss 300/1500
x 100)                                 ..........       20

The basis of the barn and of the tractor are adjusted only by the
amount of depreciation actually allowed under section 183 with
respect to each (as determined by the above computation). The
basis of the asset with regard to which the casualty loss was
suffered is adjusted only to the extent of the amount of the
casualty loss actually allowed as a deduction under subparagraph
(1)(i) and (iii) of this paragraph.

(4) Rule for capital gains and losses.-- (i) In general. For
purpose of section 183 and the regulations thereunder, the gross
income from any activity not engaged in for profit includes the
total of all capital gains attributable to such activity
determined without regard to the section 1202 deduction. Amounts
attributable to an activity not engaged in for profit which would
be allowable as a deduction under section 1202, without regard to
section 183, shall be allowable as a deduction under section
183(b)(1) in accordance with the rules stated in this
subparagraph.

(ii) Cases where deduction not allowed under section 183. No
deduction is allowable under section 183(b)(1) with respect to
capital gains attributable to an activity not engaged in for
profit if--

(a) Without regard to section 183 and the regulations thereunder,
there is no excess of net long term capital gain over net
short-term capital loss for the year, or,

(b) There is no excess of net long-term capital gain attributable
to the activity over net short-term capital loss attributable to
the activity.

(iii) Allocation of deduction. If there is--

(a) An excess of net long-term capital gain over net short-term
capital loss attributable to an activity not engaged in for
profit, and

(b) Such an excess attributable to all activities, determined
without regard to section 183 and the regulations thereunder, the
deduction allowable under section 183(b)(1) attributable to
capital gains with respect to each activity not engaged in for
profit (with respect to which there is an excess of net long
term capital gains over net short-term capital loss for the
year) shall be an amount equal to the deduction allowable under
section 1202 for the taxable year (determined without regard to
section 183) multiplied by a fraction the numerator of which is
the excess of the net long-term capital gain attributable to
the activity over the net short-term capital loss for all
activities with respect to which there is such excess. The
amount of the total section 1202 deductions allowable for the
year shall be reduced by the amount determined to be allocable
to activities not engaged in for profit and accordingly to
activities not engaged in for profit and accordingly allowed
as a deduction under section 183(b)(1).

(iv) Example. The provisions of this subparagraph may be
illustrated by the following example:

Example. A, an individual who uses the cash receipts and
disbursement method of accounting and the calender year as
the taxable year, has three activities not engaged in for
profit. For his taxable year ending on December 31, 1973, A
has a $ 200 net long-term capital gains from activity No.
1, a $ 100 net short-term capital loss from activity No. 2,
and a $ 300 net long-term capital gain from activity No. 3. In
addition, A has a $ 500 net long-term capital gain from another
activity which he engages in for profit. A computes his
deduction for capital gains for calendar year 1973 as follows:

Section 102 deduction with regard to section 183 is
determined as follows:

Net long-term capital gain from activity No. 1
                                       .......... $    200

Net long-term capital gain from activity No. 2
                                       ..........      300
Net long-term capital gain from activity
engaged in for profit                  ..........      500
                                       ___________________

Total net long-term capital gain
from all activities                                  1,000

Less: Net short-term capital loss
attributable activity No. 2            ..........      100
                                       ___________________

Aggregate net long-term capital
gain over net short-term capital
loss from all activities                                900
                                       ___________________
                                       ___________________

Section 1202 deductions
determined without regard to
section 183 (one-half of $ 900)                        450


Allocation of the total section 1202 deduction among A's various
activities:

Portion allocable to activity No. 1 which is deductible under
section 183(b)(1) (Excess net long-term capital gain attributable
to all of A's activities with respect to which there is sic an
excess ($ 1,000) times amount of section 1202 deduction ($ 450)

                                       .......... $    90

Portion allocable to activity No. 3 which is deductible under
section 183(b)(1) (Excess net long-term capital gain attributable
to activity No. 3 ($ 300) over total excess of net long-term
capital gain attributable to all of A's activities with respect to
which there is such an excess ($ 1,000) times amount of section
1202 deduction ($ 450))

                                       ..........     135

Portion allocable to all activities engaged in for profit (total
section 1202 deductions ($ 450) less section 1202 deduction
allowable to activities Nos. 1 and 3 ($ 225))

                                                      225
                                       __________________

Total section 1202 deduction deductible
under sections 1202 and 183(b)(1)                     450
                                       __________________
                                       __________________

(c) Presumption that activity is engaged in for profit-- (1) In
general. If for--

(i) Any 2 of 7 consecutive taxable years, in the case of an
activity which consists in major part of the breeding, training,
showing, or racing of horses, or

(ii) Any 2 of 5 consecutive taxable years, in the case of any
other activity,

The gross income derived from an activity exceeds the deductions
attributable to such activity which would be allowed or allowable
if the activity were engaged in for profit, such activity is
presumed, unless the Commissioner establishes to the contrary to
be engaged in for profit.

/* This is certainly not the only test. */

For purposes of this determination the deduction permitted by
second 1202 shall not be taken into account. Such presumption
applies with respect to the second profit year and all years
subsequent to the second profit year within the 5- or 7- year
period beginning with the first profit year. This presumption
arises only if the activity is substantially the same activity
for each of the relevant taxable years, including the taxable
year in question. If the taxpayer does not meet the requirements
of section 183(d) and this paragraph, no inference that the
activity is not for profit shall arise by reason of the
provisions of section 183. For purposes of this paragraph, a net
operating loss deduction is not taken into account as a
deduction. For purposes of this subparagraph a short taxable year
constitutes a taxable year.

(2) Examples. The provisions of subparagraph (1) of this
paragraph may be illustrated by the following examples, in each
of which it is assumed that the taxpayer has not elected, in
accordance with section 183(e), to postpone determination of
whether the presumption described in section 183(d) and this
paragraph is applicable.

Example (1). For taxable years 1970-1974, A, an individual who
uses the cash receipts and disbursement method of accounting and
the calendar year as the taxable year as the taxable year, is
engaged in the activity in farming. In taxable years 1971, 1973,
and 1974, A's deductible expenditures with respect to such
activity exceed his gross income from the activity. In taxable
years 1970 and 1972 A has income from the sale of farm produce of
$ 30,000 for each year. In each out of such years A had expenses
for feed for his livestock of $ 10,000, depreciation of equipment
of $ 10,000, and fertilizer cost of $ 5,000 which he elects to
take as a deduction. A also has a net operating loss carryover to
taxable year 1970 of $ 6,000. A is presumed, for taxable years,
1972, 1973, and 1974, to have engaged in the activity of farming
for profit, since for 2 years of a 5-consecutive period the
gross income from the activity ($ 30,000 for each year) exceeded
the deductions (computed without regard to net operating loss)
which are allowable in the case o the activity ($ 25,000 for each
year.)

Example (2). For the taxable years 1970 and 1971, B, an
individual who uses the cash receipts and disbursement method of
accounting and the calendar year as taxable year, engaged in
raising pure-bred Charolais cattle for breeding purposes. The
operation showed a loss during 1970. At the end of 1971, B sold a
substantial portion of his herd and the cattle operation showed a
profit for that year. For all subsequent relevant taxable years B
continued to keep a few Charolias bulls at stud. In 1972, B
started to raise Tennessee Walking Horses for breeding and show
purposes, utilizing substantially the same pasture land, barns,
and (with structural modifications) the same stalls. The Walking
Horse operations showed a small profit in 1973 and losses in 1972
and 1972 through 1976.

(i) Assuming that under paragraph (d)(1) of this section the
raising of cattle and raising of horses are determine to be
separate activities, no presumption that the Walking Horse
operation was carried on for profit arises under section 183(d)
and this paragraph since this activity was not the same activity
that generated the profit in 1971 and there are not, therefore, 2
profit years attributable to the horse activity.

(ii) Assuming the same facts as in (1) above, if there were no
stud fees received in 1972 with respect to Charolias bulls, but
for 1973 stud fees with respect to such bulls exceed deductions
attributable to maintenance of the bulls in that year, the
presumption will arise under section 183(d) and this paragraph
with respect to the activity of raising and maintaining Charolais
cattle for 1973 and for all subsequent years within the 5-year
period beginning with taxable year 1971, since the activity of
raising and maintaining Charolais cattle is the same activity in
1971 and 1973, although carried on by B on a much reduced basis
and in a different manner. Since it has been assumed that the
horse and cattle operations are separate activities, no
presumption will arise with respect to the Walking Horse
operation because there are not 2 profit years attributable to
such horse operation during the period in question.

(iii) Assuming, alternatively, that the raising of cattle and
raising of horses would be considered a single activity under
paragraph (d)(1) of this section, B would receive the benefit of
the presumption beginning in 1973 with respect to both the cattle
and horses since there were profits in 1971 and 1973. The
presumption would be effective through 1977 (and longer if there
is an excess of income over deductions in the activity in 1974,
1975, 1976, or 1977 which would extend the presumption) if, under
section 183(d) and subparagraph (3) of this paragraph, it was
determined that the activity consists in major part of the
breeding, training, showing or racing of horses. Otherwise, the
presumption would be effective only through 1975 (assuming no
excess of income over deductions in this activity in 1974 or 1975
which would extend the presumption.

(3) Activity which consists in major part of the breeding,
training, showing, or racing of horses. For purposes of this
paragraph an activity consists in major part of the breeding,
training, showing, or racing of horses for the taxable year if
the average of the portion of expenditures attributable to
breeding, training, showing, and racing of horses for the 3
taxable years preceding the taxable year (or, in the case of an
activity which has not been conducted by the taxpayer for 3
years, for so long as it has been carried on by him) was at least
50 percent of the total expenditures to the activity for such
prior taxable years.

(4) Transitional rule. In applying the presumption described in
section 183(d) and this paragraph, only taxable years beginning
after December 31, 1969, shall be taken into account.
Accordingly, in the case of an activity referred to in
subparagraph (1)(i) or (ii) of this paragraph, section 183(d)
does not apply prior to the second profitable taxable year
beginning after December 31, 1969, since taxable years prior to
such date are not taken into account.

(5) Cross reference. For rules relating to section 183(e) which
permits a taxpayer to elect to postpone determination of whether
an activity shall be presumed to be "an activity engaged in for
profit" by operation of the presumption described in section
183(d) and this paragraph until after the close of the fourth
taxable year (sixth taxable year, in the case of activity which
consists in major part of breeding, training, showing or racing of
horses) following the taxable year in which the taxpayer first
engages in the activity, see Section 1.183-3.

(d) Activity defined- (1) Ascertainment of activity. In order to
determine whether, and to what extent, section 183 and the
regulations thereunder apply, the activity or activities of the
taxpayer must be ascertained. For instance, where the taxpayer is
engaged in several undertakings, each of these may be a separate
activity or activities of the taxpayer must be ascertained. For
instance, where the taxpayer is engaged in several undertakings,
each of these may be a separate activity, or several undertakings
may constitute one activity. In ascertaining the activity or
activities of the taxpayer, all the facts and circumstances of
the case must be taken into account. Generally, the most
significant facts and circumstances of the case must be taken
into account. Generally, the most significant facts and
circumstances in making this determination are the degree of
organization and economic interrelationship of various
undertakings, the business purpose which is (or might be) served
by carrying on the various undertakings separately or together in
a trade or business or in an investment setting, and the
similarity of various undertakings. Generally, the Commissioner
will accept the characterization by the taxpayer of several
undertakings either as a single activity or as separate
activities. The taxpayer's characterization will not be accepted,
however, when it appears that his characterization is artificial
and cannot be reasonably supported under the facts and
circumstances of the case. If the taxpayer engages in two or more
separate activities, deductions and income are not aggregated
either in determining whether a particular activity is engaged in
for profit or in applying section 183. Where land is purchased or
held primarily with the intent to profit from increase in its
value, and the taxpayer also engages in farming on such land, the
farming and the holding of the land will ordinarily be considered
a single activity only if the income derived from farming exceeds
the deductions attributable to the farming activity which are not
directly attributable to the farming activity which are not
directly attributable to the holding of the land (that is,
deductions other than those directly attributable to the holding
of the land such as interest on a mortgage secured by the land,
annual property taxes attributable to the land and improvements,
and depreciation of improvements to the land.

(2) Rules for allocation of expenses. If the taxpayer is engaged
in more than one activity, an item of deduction or income may be
allocated between two or more of these activities. Where property
is used in several activities, and one or more of such activities
is determined not to be engaged for profit, deductions relating
to such property must be allocated between the various activities
on a reasonable and consistently applied basis.

(3) Example. The provisions of this paragraph may be illustrated
by the following example:

Example. (i) A, an individual, owns a small house located near
the beach in a resort community. Visitors come to the area for
recreational purposes during only 3 months of the year. During
the remaining 9 months of the year houses such as A's are not
rented. Customarily, A arranges that the house will be leased for
2 months of 3-month recreational season to vacationers and
reserves the house for his own vacation during the remaining
month of the recreational season. For 1971, the expenses
attributable to the house are $ 1,200 interest, $ 600 real estate
taxes, $ 600 maintenance $ 300 utilities, and $ 1,200 which
would have been allowed as depreciation had the activity been
engaged in for profit. Under these facts and circumstances, A is
engaged in a single activity, holding the because house primarily
for personal purposes, which is an "activity not engaged in for
profit"within the meaning of section 183(c). See paragraph (b)(9)
of Section 1.183-2.

(ii) SInce the $ 1,200 of interest and the $ 600 of real estate
taxes are specifically allowable as deductions under sections 163
and 164(a) without regard to whether the beach house activity is
engaged in for profit, no allocation of these expenses between
the use of the beach house is necessary. However, since section
262 specifically disallows personal, living, and family expenses
as deductions, the maintenance and utilities expenses and the
depreciation from the activity must be allocated between the
rental use and the personal use of the beach house. Under the
particular facts and circumstances, 2/3 (2 months of rental use
over 3 months of total use) of each of these expenses are
allocated to the personal use as follows:

                         Rental                  Personal use
                         use 2/3-- expenses      use 1/3--
                         allocated to            expenses
                         section 183(b)(2)       allocatable to
                                                 section 262
________________________________________________________________


Maintenance expense
$ 600                    $  400                   $ 200

Utilities expense
$ 300                    $  200                   $ 100

Depreciation
$ 1,200                  $  800                   $ 400

________________________________________________________________

Total                    $ 1400                   $ 700


The $ 700 of expenses and depreciation allocated to the personal
use of the beach house are disallowed as a deduction under
section 262. In addition, the allowability of each of the
expenses and the depreciation allocated to section 183(b)(2) is
determined under paragraph (b)(1)(ii) and (iii) of this section.
Thus, the maximum amount allowable as a deduction under section
183(b)(2) is $ 200 ($ 2,000 gross income from activity, less $
1,800 deduction under section 183(b)(1)). Since the amounts
described in paragraph (b)(1)(ii) of this section ($ 600) exceed
such maximum amount allowable ($200), none of the depreciation
(an amount described in paragraph (B)(i)(iii) of this section) is
allowable as a deduction.

(e) Gross income from activity not engaged in for profit defined.
For purposes of section 183 and the regulations thereunder, gross
income derived from an activity not engaged in for profit
includes the total of all gains from the sale, exchange, or other
disposition of property, and all other gross receipts derived
from such activity. The taxpayer may determine gross income from
any activity by subtracting the cost of goods sold from the gross
receipts so long as he consistently does so and follows generally
accepted methods of accounting in determining such gross income.

(f) Rule for electing small business business corporations.
Section 183 and this section shall be applied at the corporate
level in determining the allowable deductions of an electing
small business corporation.

Section 1.183-2 Activity not engaged in for profit defined.

(a) In general. For purposes of section 183 and the regulations
thereunder, the term "activity not engaged in for profit" means
any activity other than one with respect to which deductions are
allowable for the taxable year under section 162 or under
paragraph (1) or (2) of section 212. Deductions are allowable
under section 162 for expenses of carrying on activities which
constitute a trade or business and under section 212 for expenses
incurred in connection with activities engaged in for the
production or collection of income or for the management,
conservation, or maintenance of property held for the production
of income. Except as provided in section 183 and Section 1.183-1,
no deductions are allowable under section 162 or 212 for
activities which are not engaged in for profit. Thus, for
example, deductions are not allowable under 162 or 212 for
activities carried on primarily as a sport, hobby, or for
recreation. The determination whether an activity is engaged in
for profit is to be made by reference to objective standards,
taking into account all of the facts and circumstances of each
case. Although a reasonable expectation of profit is not
required, the facts and circumstances must indicate that the
taxpayer entered into the activity, or continued the activity,
with the objective of making a profit. In determining whether
such objective exists, it may be sufficient that there is a small
chance of making a large profit. Thus it may be found that an
investor in a wildcat oil well who incurs very substantial
expenditures is in the venture for profit even though the
expectation of a profit might be considered unreasonable. In
determining whether an activity is engaged in for profit, greater
weight is given to objective facts than to the taxpayer's mere
statement of intent.

(b) Relevant factors. In determining whether an activity is
engaged in for profit, all facts and circumstances with respect
to the activity are to be taken into account. No one factor is
determinative in making this determination.

/* Sorry guys. I didn't determine to write that. */

In addition, it is not intended that only the factors described
in this paragraph are to be taken into account in making this
determination, or that a determination is to be made on the basis
that the number of factors (whether or not listed in this
paragraph) indicating a lack of profit objective exceeds the
number of factors (whether or not listed in this paragraph)
indicating a lack of profit objective exceeds the number of
factors indicating a profit objective, or vice versa. Among the
factors which should normally be taken into account are the
following:

(1) Manner in which the taxpayer carries on the activity. The
fact that the taxpayer carries on the activity in a businesslike
manner and maintains complete and accurate books and records may
indicate that the activity is engaged in for profit. Similarly,
where an activity is carried on in a manner substantially similar
to other activities of the same nature which are profitable, a
profit motive may be indicated. A change of operating methods,
adoption of new techniques or abandonment of unprofitable methods
in a manner consistent with an intent to improve profitability
may also indicate a profit motive.

(2) The expertise of the taxpayer or his advisors. Preparation
for the activity by extensive study of its accepted business,
economic, and scientific practices, or consultation with those who
are expert therein, may indicate that the taxpayer has a profit
motive where the taxpayer carries on the activity in accordance
with such practices. Where a taxpayer has such preparation or
procures such expert advice, but does not carry on the activity
in accordance with such practices, a lack of intent to derive
profit may be indicated unless it appears that the taxpayer is
attempting to develop new or superior techniques which may result
in profit from the activity.

(3) The time and effort expended by the taxpayer in carrying on
the activity the fact that the taxpayer devotes much of his
personal time and effort to carrying on an activity, particularly
if the activity does not have substantial personal or
recreational aspects, may indicate an intention to derive a
profit. A taxpayer's withdrawal from another occupation to devote
most of his energies to the activity may also be evidence that
the activity is engaged in for profit. The fact that taxpayer
devotes a limited amount of time to an activity does not
necessarily lack of profit motive where the taxpayer employs
competent and qualified persons to carry on such activity.

(4) Expectation that assets used in activity may appreciate in
value. The term "profit" encompasses appreciation in the value of
assets, such as land, used in the activity. Thus, the taxpayer
may intend to profit from the operation of the activity, and may
also intend that, even if no profit from current operations is
derived, an overall profit will result when appreciation in the
value of land used in the activity is realized since income from
the activity is realized since income from the activity together
with the appreciation of land will exceed expenses of operation.
See, however, paragraph (d) of Section 1.183-1 for definition of
an activity in this connection.

(5) The success of the taxpayer in carrying on other similar or
dissimilar activities. The fact that the taxpayer has engaged in
similar activities in the past and converted them from
unprofitable to profitable enterprises may indicate that he is
engaged in the present activity for profit, even though the
activity is presently unprofitable.

(6) The taxpayer's history of income or losses with respect to
the activity. A series of losses during the initial or start-up
stage of an activity may not necessarily be an indication that
the activity is not engaged in for profit. However, where losses
continue to be sustained beyond the period which customarily is
necessary to bring the operation to profitable status such
continued losses, if not explainable, as due to customary
business risks or reserves, may be indicative that the activity
is not being engaged in for profit.

(7) The amount of occasional profits, if any, which are earned.
The amount of profits in relation to the amount of losses
incurred, and in relation to the amount of the taxpayer's
investment and the value of the assets used in the activity, may
provide useful criteria in determining the taxpayer's intent. An
occasional small profit from an activity generating large losses,
or from an activity in which the taxpayer has made a large
investment, would not generally be determinative that the
activity is engaged in for profit. However, substantial profit,
though only occasional, would generally be indicate that an
activity is engaged in for profit, where the investment or losses
are comparatively small. Moreover, an opportunity to earn a
substantial ultimate profit in a highly speculative venture is
ordinarily sufficient to indicate that the activity is engaged in
for profit even though losses or occasional small profits are
actually generated.

(8) The financial status of the taxpayer. The fact the taxpayer
does not have substantial income or capital from source other
than the activity is engaged in for profit. Substantial income
from source other than the activity (particularly if the losses
from the activity generate substantial tax benefits) may indicate
that the activity is not engaged in for profit especially if
there are personal or recreational elements involved.

(9) Elements of personal pleasure or recreation. The presence of
personal motives in carrying on of an activity may indicate that
the activity is engaged in for profit, especially where there are
recreational or personal elements involved. On the other hand, a
profit motivation may be indicated where an activity lacks any
appeal other than profit. It is not, however, necessary that an
activity be engaged in with the exclusive intention of deriving a
profit or with the intention of maximizing profits. For example,
the availability of other investments which would yield a higher
return, or which would be more likely to be profitable is not
evidence that an activity is not engaged in for profit. An
activity will not be treated as not engaged in for profit merely
because the taxpayers has purposes or motivation other than
solely to make a profit. Also, the fact that the taxpayer derives
personal pleasure from engaging in the activity is not sufficient
to cause the activity to be classified as not engaged in for
profit as evidenced by other factors whether or not listed in this
paragraph.

(c) Examples. The provisions of this section may be illustrated
by the following examples:

Example (1). The taxpayer inherited a farm from her husband in an
area which was becoming largely residential, and is now nearly
all so. The farm had never made a profit before the taxpayer
inherited it, and the farm has since had substantial losses in
each year. the decedent from whom the taxpayer inherited the farm
was a stockholder, and he also left the taxpayer substantial
stock holdings which yield large income from dividends. The
taxpayer lives on an area of the farm which is set aside
exclusively for living purposes. A farm manager is employ to
operate the farm, but modern methods are not used in operating
the farm. The taxpayer was born and raised on a farm, and express
a strong preference for living on a farm. The taxpayer's activity
of farming, based on all the facts and circumstances, could be
found not to be engaged in profit.

Example (2). The taxpayer is a wealthy individual who is greatly
interested in philosophy. During the last 30 years he has written
and published at his own expense several pamphlets, and he has
engaged in extensive lecturing activity, advocating and
disseminating his ideas. He has made a profit from these
activities in only occasional years, and the profits in those
years were small in relation to the amount of the losses in all
other years. The taxpayer has very sizable income from securities
(dividends and capital gains) which constitutes the principal
source of his livelihood. The activity of lecturing, publishing
pamphlets, and disseminating his ideas is not an activity engaged
in by the taxpayer for profit.

Example (3). The taxpayer, very successful in the business of
retailing soft drinks, raises dogs and houses. He began raising a
particular breed of dog many years ago in the belief that the
breed was in danger of declining, and he has raised and sold the
dogs in each year since. The taxpayer recently began raising and
racing thoroughbred horses. The losses from the taxpayer's dog
and horse activities have increased in magnitude over the years,
and he has not made a profit on these operations during any of
the last 15 years. The taxpayer generally sells the dogs only to
friends, does not advertise the dogs for sale, and shows the dogs
only infrequently. The taxpayer races his horses only at the
"prestige" tracks at which he combines his racing activities with
social and recreational activities. The horse and dog operations
are conducted at a large residential property on which the
taxpayer also lives, which includes substantial living quarters
and attractive recreational facilities for the taxpayer and his
family. Since (i) the activity of raising dogs and horses and
racing the horses is of a sporting and recreational nature, (ii)
the taxpayer has substantial income from his business activity of
retailing soft drinks, (iii) the horse and dog operations are not
conducted in a businesslike manner, and (iv) such operations have
a continuous record of losses, it could be determined that the
horse and dog activities of the taxpayer are not engaged in for
profit.

Example (4). The taxpayer inherited a farm of 65 acres from his
parents when they died 6 years ago. The taxpayer moved to the
farm from his house in a small nearby town, and he operates it in
the same manner as his parents operated the farm before they
died. The taxpayer is employed as a skilled machine operator in a
nearby factory, for which he is paid approximately $ 8,500 per
year. The farm has not been profitable for the past 15 years
because of rising costs of operating farms in general, and
because of the decline in the price of the produce of this farm
in particular. The taxpayer consults the local agent of the State
agricultural service from time to time, and the suggestions of
the agent have generally been followed. the manner in which the
farm is operated by the taxpayer is substantially similar to the
manner in which farms of similar size, and which grow similar
crops in the area, are operated. Many of these other farms do not
make profits. The taxpayer does much of the required labor around
the farm himself, such as fixing fences, planting crops, etc. The
activity of farming could be found, based on all the facts and
circumstances, to be engaged in by the taxpayer for profit.

Example (5). A, an independent oil and gas operator, frequently
engages in the activity of searching for oil on undeveloped land
which is not near proven fields. He does so in a manner
substantial similar to that of others who engage in the same
activity. The chances, based on the experience of A and others
who engaged in this activity, are strong that A will not find a
commercially profitable oil deposit when he drills on land not
established geologically to be proven oil bearing land. However,
on the rare occasions that these activities do result in
discovering a well, the operator generally realizes a very large
return form such activity. Thus, there is a small chance that A
will make a large profit from his soil exploration activity.
Under these circumstances, A is engaged in the activity of oil
drilling for profit.

Example (6). C, a chemist, is employed by a large chemical
company and is engaged in a wide variety of basic research
projects for his employer. Although he does no work for his
employer in respect to the development of new plastics, he has
always been interested in such development and has outfitted a
workshop in his home at his own expense which he uses to
experiment in the field. He has patented several developments at
his own expense but as yet has realized no income from his
inventions or from such patents. C conducts his research on a
regular, systematic basis, incurs fees to secure consultation on
his projects from time to time, and makes extensive efforts to
"market" his developments. C has devoted substantial time and
expense in an effort to develop a plastic sufficiently hard,
durable, and malleable that it could be used in lieu of sheet
steel in many major applications, such as automobile bodies.
Although there may be only be a small chance that C will invent
small plastics, the return from any such development would be so
large that it induces C to incur the costs of his experimental
work. C is sufficiently qualified by his background that there is
some reasonable basis for his experimental activities. C's
experimental work does not involve substantial personal or
recreational aspects and is conducted in an effort to find
practical applications for his work. Under these circumstances, C
may be found to be engaged in the experimental activities for
profit.