I have a side gig speculating in domain names. This entails: Looking for unregistered domains that I think have valueValuing domains using various websitesRegistering and renewing the domains, generally for multiple yearsListing the domains for sale on online brokeragesNegotiating with buyersTransferring domains to the buyer A couple of questions: Should I consider this a (Schedule C) business, in which the domain names are my inventory? Or are my domain names investments that would generate capital gains/losses rather than business gains/losses?At this point, I've retired from searching for new names for several years. Now I just maintain my existing inventory and very occasionally sell a domain (e.g., maybe one a year). Does this change the situation? (E.g., does this mean I'm no longer an "active" participant in the business?)

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evil_shenanigans

Question

Trading domain names - business or investment?

Forum|Forum|5 years ago
August 12, 2020
2 replies
0 views

I have a side gig speculating in domain names. This entails:

Looking for unregistered domains that I think have value
Valuing domains using various websites
Registering and renewing the domains, generally for multiple years
Listing the domains for sale on online brokerages
Negotiating with buyers
Transferring domains to the buyer

A couple of questions:

Should I consider this a (Schedule C) business, in which the domain names are my inventory? Or are my domain names investments that would generate capital gains/losses rather than business gains/losses?
At this point, I've retired from searching for new names for several years. Now I just maintain my existing inventory and very occasionally sell a domain (e.g., maybe one a year). Does this change the situation? (E.g., does this mean I'm no longer an "active" participant in the business?)

Not A Product Question

M-MTax

You have to make the call whether this is a business or an investment or a hobby.....depends on your intent and other factors.

Opus 17

Employee

Here are some guides to whether an activity is a business or hobby.

https://turbotax.intuit.com/tax-tips/small-business-taxes/when-the-irs-classifies-your-business-as-a-hobby/L5NClTTtK

https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/income-expenses

You are a business if you are engaged in an "ongoing trade or business" meaning you do things that businesses do; you seek out new customers, you try to make a profit, you advertise, and generally act in a "businesslike manner". There is rarely a black and white distinction, it is the overall culmination of factors.

It's not a question of whether you are an active or passive participant in your business, but whether you are a business at all.

Then, there is a separate question over when an investor/day trader performs so much trading activity that they can be considered self-employed and use a schedule C to deduct expenses. (The profit and loss from capital investing is still reported on schedule D, but a trader who makes trading their "business" can sometimes deduct other expenses like an office, computer, and expenses for doing investment research.)

Buying and selling property (which this is, even though the property is intangible) creates capital gains and losses which are reported on schedule D. Nothing happens on your tax return when you buy something. When you sell it, you have a capital gain or loss. You have a gain if you sell the property for more than you paid for it (your adjusted cost basis). If you have carrying expenses in the mean time, you can "capitalize" your expenses (add them to your cost basis) but this sometimes requires sending a written statement to the IRS each year attached to your tax return explaining what costs are being capitalized to which property assets.

(A simple example is buying a vacant lot for investment purposes and hoping to sell it later. In the mean time, you pay property taxes and expenses to keep the lot cleared and free of other people's trash. You generally can't deduct those expenses on schedule C because you aren't an active enough investor to use a schedule C. But you can capitalize the expenses by adding them to the cost which reduces your taxable gain when you sell. This requires attaching a statement to your tax return. Domain names seem similar in concept.)

Based on your statement, you probably would not qualify to use schedule C for your expenses. If you sell any domains, you have a capital gain on schedule D. Whether you can capitalize your annual carrying costs without having previously reported an election to do so on previous tax returns would require a professional to advise you.

How have you reported income and paid taxes on the domains you previously sold?

evil_shenanigansAuthor

@Opus 17- thanks as always for your detailed response! Yes, I've previously treated this activity as a Schedule C business. I've reported sales income and managed expenses as inventory (i.e. cost of goods sold).

After reviewing the links you sent, I'd say it's still a bit murky whether this qualifies as a business or not. Certainly my intention was to make a profit, but I pretty quickly (within a few months) gave up actively pursuing this activity when I realized it was taking much more time than I anticipated and thus the cost-benefit analysis didn't add up for me. Since that time, 2016 I think, I've just basically sat on the domains and still occasionally sell one when somebody finds it on a brokerage site. Due to essentially random fluctuation, some years I have a net profit and some a net loss.

Here are the IRS criteria and my response to them:

Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records. [Yes. My records are impeccable.]
Whether the time and effort you put into the activity indicate you intend to make it profitable. [Unclear. I invested considerable time and effort for several weeks/months at the outset, and little since.]
Whether you depend on income from the activity for your livelihood. [No]
Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business). [Unclear. My losses are just due to registration costs in years where I didn't happen to sell enough domains to make up for them.]
Whether you change your methods of operation in an attempt to improve profitability. [Unclear. I didn't really stick with it long, but arguably I did this by exploring different auction sites / brokerages to list the domains on.]
Whether you or your advisors have the knowledge needed to carry on the activity as a successful business. [Unclear. I guess not since I don't really make any money.]
Whether you were successful in making a profit in similar activities in the past. [NA]
Whether the activity makes a profit in some years and how much profit it makes. [Yes. Not much -- a few hundred bucks at the most.]
Whether you can expect to make a future profit from the appreciation of the assets used in the activity. [Unclear, to me at least, if domain name values are appreciating.]

Opus 17

Employee

I think that, regardless of how you operated in the past, by your own admission it's not a business any more. I don't think you should file a schedule C, and you can't deduct expenses like the annual domain registration renewal fees or a home office. Since the domains are "property" you would report their sale on schedule D as capital gains property.

I tried to figure out if you could capitalize your carrying costs under section 266 and I just don't know. Most articles about section 266 focus on real estate, and while some parts of section 266 refer to real property, other places just say "property." But the tax reform law of 2018 also affected section 266. So the bottom line is I just don't know. You would have to get professional advice if you want to find some way to deduct your carrying costs.

https://www.law.cornell.edu/cfr/text/26/1.266-1

(For example, suppose you bought gold as an investment and paid someone to store it in a vault. Under the old law, the storage fees were a deductible expense as itemized miscellaneous deductions subject to the 2% rule. Your domain registration fees would have been deductible under the same theory, assuming you were holding the domains as investments and not able to deduct the expenses on schedule C. The TCJA of 2018 eliminated the misc itemized deduction. So now, the question is that when section 266 says "you can elect to capitalize expenses that would ordinarily be deductible" can you still elect to capitalize your carrying costs, or are they not eligible for section 266 because they are no longer deductible as itemized deductions. The IRS has not ruled on this question, apparently.)