Non-Commercial Losses Explained (2023)

Are you running a business activity and are unsure if you can claim deductions on expenses? As either a sole trader or a partnership engaging in a business activity separate from your primary income source, it's essential to understand non-commercial loss rules. Non-commercial losses refer to the financial losses incurred from such business activities that lack a significant commercial purpose or character.

While you might not be able to offset these losses against your other income immediately, there are tests in place that determine when and how you can offset or defer these losses. Let's delve into the rules for non-commercial losses and discover how they can impact your tax situation and business ventures.

The Basics of Non-Commercial Losses

To start, it's important to differentiate between a business and a hobby. A non-commercial business refers to a business activity that is not the primary source of income and lacks a significant commercial purpose.

On the other hand, hobbies are pursued for personal enjoyment without the intention of generating substantial profits. There are four tests you can complete to tell if your business losses can be tax deductible or if they are non-commercial losses.

Who does it Mainly Apply to?

A non-commercial business is typically either a sole trader or a partnership. A lot of individuals who have a hobby or lifestyle business such as freelancing photography can be counted as a hobby business if you meet the criteria from the ATO. This isn't all bad however as the profit won't count on your assessable income, but you will also have to follow the non-commercial loss rules.

Assessable Income Test

Imagine you have a business activity on the side, like selling homemade crafts or offering freelance services. The assessable income test is like a checkpoint to determine if your business is making enough money to offset its losses against your other income. To pass this test, the assessable income turnover you earn from your business during the year must be at least $20,000.

This includes the money you make from your sales or services. If your business income meets or exceeds that amount, you can claim your losses in the same year. However, if your business income falls below the $20,000 mark, you may need to wait until your business starts making more money before you can use those losses to reduce your overall taxes.

So, it's important to keep track of your business earnings to see if you pass the assessable income test and can benefit from the losses incurred in your business activity.

Profits Test

The profits test is an important factor when determining how non-commercial losses can be offset against other income. This test looks at the profitability of your business over a period of time. To pass the profits test, your business must have made a tax profit in at least three out of the past five years, including the current year.

When calculating the profit, any losses that were deferred from previous years are excluded. If your business makes a tax profit for three consecutive years it will pass the profits test for the next two years regardless of whether it makes a loss.

In other words, it allows you to offset the losses from your non-commercial business against your other income, even if your business incurs losses in the current year. It recognises the overall profitability of your business activity, providing you with greater flexibility in utilising your losses to reduce your taxable income.

Real Property Test

When it comes to the real property test, things get real! This test focuses on the value of the property used in your business activity. To pass the real property test, you need to have real property worth at least $500,000 that is consistently utilised in your business.

Real property includes land, buildings, and leases of property. However, it doesn't include your private residence or fixtures owned as a tenant. So, if you're rocking some valuable real estate in your business operations, meeting this test means you can offset your non-commercial losses against your other income.

It's like a property power-up that can help you make the most of your business losses and potentially reduce your taxable income.

Other Assets Test

Get ready to assess your assets because we're diving into the other assets test! This test focuses on the value of the non-real property assets used in your business activity. Think equipment, trading stock, leased assets, and even trademarks or copyrights.

To pass the test, the combined value of these assets must be at least $100,000. It's like a treasure hunt, determining the worth of your business tools and resources. If you meet this test, you gain the power to offset your non-commercial losses against your other income.

It's all about recognising the value of your business assets and using them strategically to unlock potential tax benefits. So, gather your assets, evaluate their worth, and see if you're ready to level up your tax game!

Other Rules to be Wary of

The non-commercial loss rules come with an exemption known as the "excepted activities" provision. This exemption applies to specific business activities, namely professional arts businesses. This is to allow a professional arts business to provide more flexibility for individuals engaged in these fields.

To qualify for the exemption, your assessable income from other sources (excluding any net capital gains) must be below a certain threshold, which is typically set at $40,000. If your income meets this requirement, you can offset your losses from your professional arts business activities against your other income.

Moreover, the total net investment losses, including both financial investment losses and rental property losses, play a role in determining your eligibility for this exemption. If your total net investment losses align with the set criteria, you can take advantage of this special provision, providing relief for those engaged in professional arts businesses.

Conclusion

Understanding and navigating the world of non-commercial losses rules is crucial for individuals involved in business activities that are not their primary source of income. By comprehending the assessable income test, profits test, real property test, and assets test, individuals can determine their eligibility to offset or defer their business losses against their other income.

These tests help ensure fairness and accountability in tax deductions, allowing individuals to make the most of their business activities. So, take charge of your business activities, explore the rules, and unleash the potential of non-commercial losses in reducing your taxable income.

Every situation is different and our team of central coast accountants at Coleman Financial Group can help you, so call us today!

The information provided on this tax blog is intended for general informational purposes only and should not be considered as professional tax advice. While we strive to ensure the accuracy and currency of the content, tax laws and regulations are subject to change, and individual circumstances may vary. We recommend consulting a qualified tax professional or seeking advice from the Australian Taxation Office (ATO) for personalised guidance tailored to your specific situation. The authors and creators of this blog disclaim any liability for errors, omissions, or inaccuracies in the information provided. Use the information at your own discretion, and always exercise caution when making financial or tax-related decisions.