A possible general 'loophole' exists where a reasonable profit occurrs in two out five consecutive years of operations. If this is the case the IRS tends to assume the activity was done for profit, hence the loophole since no challenge may be in order. Note however, that the degree of profit is important compared to the degree of loss. Very small profits for two years vs large losses for the other 3 years may not be enough to keep the IRS from trying to challenge.

Since the challenge is done 'after-the-fact,' the IRS has the benefit of hindsight. It's too late for you to go back in time to shore up your position. If you lose this challenge, these losses, both future and past (within the appropriate statute of limitations), can be disallowed resulting in a possible hefty tax bill for you to pay - plus interest and possible penalties. So contemporaneous recordkeeping and marketing activities are the watchwords here.

However, if you do your homework and the loss-producing activity is handled correctly, this can be a wonderful tax-saving opportunity. You or members of your family may have the chance to enjoy a fun activity, write-off its expenses, and reduce your taxes all at the same time. So it is worth the consideration.