If you’re just starting out in racing, you may have a fast car (or hope to), a skeleton crew, big dreams – and few funds. To help reduce the cash outflow, you might be tempted to deduct your racing expenses on your tax return, reducing your taxes and letting Uncle Sam foot part of the bill.
Sometimes it works. Often it doesn’t.
Between 1962 and 1996, over 30 cases have wound up in the courts dealing with the problem of racers attempting to deduct their expenses. Most cases have centered on the “hobby loss” rules, although a few dealt with businesses attempting to deduct racing activities as advertising. I’ve read and analyzed these cases and the results don’t look too good from the racers’ standpoint. Of these cases, only four were decided in favor of the racer.
If you’re thinking about including your racing activity on your tax return, the 900-pound gorilla in the room is something called the “hobby loss” rules. Bottom line: if your racing is considered a “hobby,” your expenses can only be deducted to the extent of your winnings. In other words, if the IRS considers your racing activity a “hobby,” you can’t show a loss for tax purposes.
In other words, if you have no revenue from racing and it's considered a "hobby," you can't deduct any expenses. None.
If you have revenue, the expenses you’re able to deduct have to be broken out into three separate categories and are deductible in a certain order.
However, if your racing is considered “profit motivated,” then all your expenses are deductible, assuming they meet the normal rules for deductibility.
What separates the “hobby” from the “profit motivated” activity? The government uses nine factors to determine whether the activity is a “hobby” or if it’s “profit-motivated.” Here they are:1
1.You conduct your racing in a business-like fashion.
2.Your expertise or that of your advisors.
3.The time and effort you expend in racing.
4.You expect that that assets used in racing may increase in value.
5.Your success in carrying out other similar or dissimilar activities.
6.Your history of income or losses with respect to racing.
7.The amount of occasional profits, if any, which are earned.
8.Your financial status.
9.Elements of personal pleasure or relaxation
As you can see, these factors are subjective. Nor are they of equal importance. For example, how can you show that you’ve conducted your racing “in a business-like fashion”? How much of the pleasure you derive from your is “too much?” These are tough questions, with no easy answers.
There are two ways to avoid this craziness. First, you can incorporate your racing program as a “C-Corporation.” Second, if you can show a profit in any three out of five prior consecutive years, your racing activities are presumed to have a profit motive, and it’s up to the government to prove otherwise.
The decision to incorporate should be made only with the assistance of an attorney. This decision has many ramifications and extra paperwork is involved, from both the legal, tax and accounting standpoint.
In the next few blogs, I’ll get into these rules and cases in more detail.
So, a word of warning: If you want to go down this road, make sure you have good advice. Consult with a competent tax advisor.
Until next time…
“This posting is intended to provide general information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional services. This information should not be used as a substitute for professional advice in specific situations. If legal advice or other expert assistance is required, the services of a professional should be sought.”
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