If one operates a business that loses money, you’re entitled to declare the loss against your overall tax liability. What I may be misunderstanding is the practice of deliberately maintaining such a liability– or even going out of one’s way to acquire ownership of one. Is there any way that such a white elephant is actually beneficial in some circumstances?
If the tax right-off exceeds the cost of running the unprofitable business, you win in the long run. But given the cost to start up and run even an unprofitable business, this may not be as straightforward as it seems.
But if that ever happens, it’s a sign that the tax code is flawed.
Probably not with just an operating loss; but if one can compound that with other tax breaks it can yield a net positive?
There are some businesses that throw off tax losses that are not matched by cash losses. I know my brother and sister in law report losses on their tax returns from real estate rental activity, but have massively positive cash flow (like to the tune of several million in the last decade). At some point in the future they might have massive tax gains that aren’t matched by cash flow, but they don’t expect that point to come until after they retire or maybe even expire.
The key is running a business at a loss where the loss exists only on paper, i.e., under accounting rules, without you having to actually fork over that amount of money. One way this can happen is via depreciation. Suppose the business involves an asset with a replacement value of $1 million. If the tax code allows you to depreciate the asset linearly over ten years, then you’re allowed to book a $100,000 expense every year for ten years which you can offset against earnings elsewhere. But you’re not actually paying anyone $100,000; the figure simply comes from a provision in the tax code that makes assumptions about the value of the asset and the depreciation period, and these assumptions may be quite different from the reality of what you’re actually paying or paid in the past.
For small, more or less one person businesses, there are a lot of ways to dump what are essentially personal living expenses onto the books of the business. Not all those ways are strictly legal per the tax code, but it’s a very common cheat.
Whether the business is profitable or not before you lumber it with personal expenses, it’ll be less profitable or even pushed into loss after you do so. If for simplicity we assume you’re in the 25% marginal tax bracket, every personal expense you slip in there amounts to getting a 25% discount on [whatever].
Back in the day when top marginal rates were more like 70%, it became real easy to persuade oneself that calling your personal car with the magnetic sign on the door a business advertising expense was a good idea. Who doesn’t want a 70% discount on the effective price of their car?
And this has just gotten even better for companies. Trump’s OBBB Act changed depreciations and other important previsions of the code. Now businesses are allowed to take 100% off such “bonus depreciation,” which can drive a tax bill below zero.
IAMATL, so look at this page for what any of that means.
How can the value of the asset that is depreciated be higher than what you originally paid for it? (If you depreciate what you paid, you only offset against earnings, over a period, what you paid but could not offset against earnings at the time of purchase).
Here’s what a friend of mine did. He started a business whose operations were giving lectures and writing books. He had actually written one book and would eventually coauthor a second. He was a fairly well-known mathematician and would be invited from time to time to give a lecture. His business income were the modest royalties from the book and the honorarium given for the lectures. Meantime, he cordoned off a corner of his house and declared that his business office. If the cordoned area was 1/5 th the total area then he deducted 20% of all expenses related to the house from his professorial income. But he had to be careful to make a modest profit (on which he paid taxes) one year in five. Otherwise the IRS would call his business a hobby and disallow the expenses. It was all a scam and the money involved was relatively modest, but he did make something from it.
My wife worked from home as a professional translator for a number of years. She used one room of the house as her office and we got to deduct from not inconsiderable income a portion of our household expenses. But she never lost money.
My understanding is that the part of the house designated as office space has to exclusively be used for that purpose. You can’t, say, use it as a guest room or as a den.
Legally, maybe, but many people don’t follow that exactly, and count on it being very difficult to get caught.
If I purchase something for $1,000,000 and depreciate it over 10 years at 100,000 per year and my [business] income is less than 100,000 in any given year, I’ll be operating at a loss during that period. Not necessarily actually losing money but, at least on paper, in the red.
Also worth keeping mind that the losses aren’t coming from nowhere, it’s moving from an asset on the balance sheet to an expense on the Income/P&L statement. Everything is on the books.
I think you can depreciate against the replacement value, which might be more than what you paid for it.
That seems unlikely. But yeah, depreciation can be a big, even the biggest deduction. Often however, depreciation is matched by a cash outflow in the terms of payments. But if you bought a apartment building for cash, you’d get to write off what you paid for it over time, IIRC 27 or so years.
So a 2.7Million building would net a 100000 write off a year.
It is the basis, which is generally what you paid for it, not the replacement value, but yes, you are correct.
Generally you cant.
That isnt really a scam, but FYI, having a office in the Home means you are very likely to get audited.
Not unless they changed the law radically recently.
Thanks.
The thought behind this thread was the following: suppose you wanted to open a restaurant that served really good high-quality food, great atmosphere, well-compensated wait staff who would provide exceptional service. But you’d run the numbers and it just wasn’t viable: you couldn’t realistically charge enough money to meet expenses because you wouldn’t have enough customers willing to pay those prices. So you seek a patron: an investor that you tell up front that this restaurant would never be able to operate in the black; but would they be willing to back it as a tax deduction? Could that actually make financial sense in the right circumstances to a potential investor?
Well, you’re still operating the restaurant at a loss, so you are still losing money the longer it stays open.
One way it might make sense is as a sort of “loss leader” where maybe it’s a highly visible flagship in a chain of more profitable restaurants. So like you have this fancy Manhattan dining experience that never makes money, but it helps lend street cred for your other franchises while providing a tax credit.
My father, who ran a hotel, once told me that the hotel restaurant usually lost money, but hotel guests expected it to be an option at any decent stay. So, that’s an example of a restaurant which would persist even as it lost money.
Not really. It is nice to have a nice fat loss in a year where you have a big profit, but not year to year.