Is Your Sideline Activity  a Business or a Hobby? 

Do you have a sideline activity that you think of as a  business?  

From this sideline activity, are you claiming tax losses on  your Form 1040? Will the IRS consider your sideline a  business and allow your loss deductions? 

The IRS likes to claim that money-losing sideline  activities are hobbies rather than businesses. The federal  income tax rules for hobbies have been anti-taxpayer for  years, and now an unfavorable change enacted in the Tax  Cuts and Jobs Act (TCJA) made things even worse for  2018-2025.  

If you have such an activity, we should have your  attention.  

Here’s the deal: if you can show a profit motive for your  now-money-losing sideline activity, you can classify that  activity as a business for tax purposes and deduct the  losses.  

Factors that can prove (or disprove) such intent include: 

• Conducting the activity in a business-like manner  by keeping good records and searching for  

profit-making strategies. 

• Having expertise in the activity or hiring  advisors who do. 
• Spending enough time to justify the notion that  the activity is a business and not just a hobby. 
• Expectation of asset appreciation: this is why the  IRS will almost never claim that owning rental  real estate is a hobby, even when tax losses are  incurred year after year. 
• Success in other ventures, which indicates that  you have business acumen. 
• The history and magnitude of income and losses  from the activity: occasional large profits hold  more weight than more frequent small profits,  and losses caused by unusual events or just plain  bad luck are more justifiable than ongoing losses  that only a hobbyist would be willing to accept. 
• Your financial status: “rich” folks can afford to  absorb ongoing losses (which may indicate a  hobby), while ordinary folks are usually trying to  make a buck (which indicates a business). 
• Elements of personal pleasure: breeding race  horses is lots more fun than draining septic tanks,  so the IRS is far more likely to claim the former  is a hobby if losses start showing up on your tax  returns. 

Self-Directed IRAs 

Tax-advantaged retirement accounts such as IRAs are a  great way to save for retirement.  

But when you establish a traditional IRA with a bank, a  brokerage, or a trust company, you are ordinarily limited  

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to a narrow range of investment options, such as CDs and  publicly traded stocks, bonds, mutual funds, and ETFs.  The IRA custodian will not permit you to invest in  alternative investments such as real estate, precious  metals, or cryptocurrency. 

A self-directed IRA could be for you if you want to walk  on the wild side and invest your retirement money in  assets such as real estate or cryptocurrency. 

You can invest in almost anything other than collectibles  such as art or rare coins, life insurance, or S corporation  stock with a self-directed IRA. Investment options  include, but are not limited to, the following: 

• Real estate 
• Private businesses 
• Trust deeds and mortgages 
• Tax liens 
• Precious metals such as gold, silver, or platinum • Private offerings 
• LLCs and limited partnerships 
• REITs 
• Livestock 
• Oil and gas interests 
• Franchises 
• Hedge funds 
• Cryptocurrency 
• Promissory notes 

Aside from the vast array of investment options, a self directed IRA is the same as a traditional IRA and subject  to the same rules. The income the investments in your  

IRA earn is not taxed until you take distributions, but  distributions before age 59 1/2 are subject to a 10 percent  penalty unless an exception applies.  

You can also have a self-directed Roth IRA for which  distributions are tax-free after five years. 

But you must avoid self-dealing and other prohibited  transactions or your self-directed IRA could lose its tax advantaged status. 

Establishing a self-directed IRA need not be too difficult.  You first open an account with a custodian that offers  self-directed investments. You can also acquire  checkbook control over your self-directed IRA by  forming a limited liability company to own all the IRA  investments. 

Investing in alternative assets such as cryptocurrency is  riskier than stocks, bonds, and mutual funds.  

• The rewards can be great, as you’ve seen with  recent returns for cryptocurrency investors.  
• And the damage to your investment portfolio can  be substantial, as we’ve also seen over the years. 

When it comes to alternative investments, you need to  know what you are doing or have an investment  professional you trust to do this for you. 

If you need help contact our trusted advisor, Kevin  Stewart, at (304) 573-9634. Tell him we sent you!!  

Using a Vacation Home as a  Rental Property and for  Personal Use 

When you use a home for both rental and personal use,  regardless of that home’s location at the beach or in the  city, you run into the tax code’s vacation home rules that  make that home either a residence or a rental property.  

It’s a residence when you 

• rent it for more than 14 days during the year and
  

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• use it for personal purposes for more than the  greater of 14 days or 10 percent of the days that  you rent the home out at fair market rates. 

Example. You own a beachfront vacation condo.  During the year, you rent it out for 180 days. You and  members of your family stay there for 90 days. The  property is vacant the rest of the year except for seven  days at the beginning of winter and seven days at the  beginning of summer, which you spend maintaining the  property. Your condo falls into the tax code–defined  personal residence because 

• you rented it out for 180 days, which is more  than 14 days, and  
• you had 90 days of personal use, which is more  than 14 days and more than 10 percent of the  rental days.  

Disregard the 14 days you spent maintaining the place. 

The fundamental principle that applies when your  vacation home is a personal residence is that expenses  other than mortgage interest and property taxes allocable  to the rental use cannot exceed the gross rental income from the property. In other words, rental operating  expenses and depreciation cannot cause a tax loss on  Schedule E of your Form 1040 for the year in question. 

Depreciating Residential  Rental and Commercial Real  Property 

When you own rental property, depreciation is your best  friend.  

One reason depreciation is so valuable is that, unlike  deductible rental property expenses such as interest and  maintenance, you get to claim depreciation year after  year without having to pay anything beyond your original  investment in the property.  

Moreover, rental real property owners are entitled to  depreciation even if their property goes up in value over  time (as it usually does). 

The basic idea behind depreciation is simple, but  applying it in practice can be complex. Indeed, the  annual depreciation deductions for two properties that  cost the same can be very different. 

For example, if you own a motel with a depreciable basis  of $1 million, you get to deduct $25,640 each year for  depreciation (except the first and last years). If you own  an apartment building with a $1 million basis, your  depreciation deduction is $36,360.  

Why the difference? A motel and apartment building are  both rental real estate. Shouldn’t they be depreciated the  same way? Not according to the tax law. An apartment  building is a residential rental property, while a motel is a  commercial rental property. There are different  depreciation periods for commercial and residential  property: it takes far longer to depreciate commercial  property fully. 

For this reason, you should always make sure you  correctly classify your property as commercial or  residential. Such classification can be more challenging  than you might think, especially for mixed-use property.  If you rent to residential and commercial tenants, the tax  code classifies the building as residential only if 80  percent or more of the gross annual rent is from renting  dwelling units.  

Even properties rented only for residential use may have  to be classified as commercial if a majority of the tenants  or guests are transients who stay only a short time. This  rule can adversely impact the depreciation deductions for  property owners who rent their property to short-term  guests through Airbnb and other short-term rental  platforms. 

If you’ve been using the wrong depreciation period for  your residential or commercial rental property, you  should correct the error by filing an amended return or  IRS Form 3115 to fix depreciation errors that are more  than two years old.

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