Understanding Deferred Non-Commercial Losses

Individuals operating a business, whether as a sole trader or in partnership, may be able to offset any losses against their other income, such as salary and wages. Businesses in the start-up phase often operate at a loss for several years, with the sole trader or partners supporting the business with their other income, typically their salary income. Deducting business losses from salary income normally results in large annual tax refunds.

Sole traders and partnerships that are operating a business at a loss will only be able to offset that loss against other income when they pass the income requirement and one of the four non-commercial loss tests. 

What is the income requirement?

Your Adjusted Taxable Income (ATI) must be less than $250,000. ATI is calculated as the taxable income (ignoring any business losses), total reportable fringe benefits amounts, reportable superannuation contributions, and total net investment losses.

What Are Non-Commercial Losses?

A non-commercial loss occurs when your business expenses exceed your income for the year. The ATO has specific rules in place to prevent individuals from using these losses to offset other income unless the business meets specific criteria. These rules are designed to ensure that only genuine, profit-making businesses receive tax relief—not hobbies or passive ventures.

When Are Losses Deferred?

If your business doesn't meet one of the ATO's four key tests (Assessable Income Test, Profits Test, Real Property Test, or Other Assets Test), or doesn't qualify for an exception (such as being in primary production or a professional arts business), then your loss will be deferred.

This means you can't claim the loss on your current year's tax return. Instead, it's carried forward and can be used to offset future business income—once your business passes a test or starts turning a profit.

Here's a breakdown of the four key tests: 

 1. Assessable Income Test

• Your business must earn at least $20,000 in assessable income during the financial year (excluding GST).
• This income must come from the business activity itself—not other sources.

 2. Profits Test

Your business must have made a profit in at least three out of the past five years, including the current year.

• The profit must come from the same business activity.
• You don't need to have made three consecutive profits—just three within the five-year period.

 3. Real Property Test

• You pass this test if your business uses real property (e.g., land or buildings) that is valued at $500,000 or more (excluding any private-use portion).
• This applies particularly to businesses like farming, accommodation, or property-related services.

 4. Other Assets Test

Your business activity must utilise other assets (excluding real property) worth at least $100,000.

Examples include:

• Equipment
• Machinery
• Vehicles
• Private-use assets must be adjusted to reflect the business-use portion only.

Exceptions to the Rules

Even if you don't pass a test, you may still be able to claim the loss if:

• You're in a primary production or professional arts business, and
• Your other income is less than $40,000. 
• There may also be the Commissioner's discretion available in certain special circumstances—such as natural disasters or unusual start-up delays.

What If You Don't Pass?

If none of the tests are met and no exception applies, the loss is deferred. This means:

• You can't deduct it from your other income this year.
• It carries forward to future years, where it can be used once your business becomes commercially viable and passes a test.

Why It Matters

Incorrectly claiming non-commercial losses can result in ATO scrutiny, penalties, and amended assessments. On the other hand, properly deferring losses ensures you're set up to claim them later—potentially reducing your tax when your business grows.

Need Help? 

Navigating the non-commercial loss rules can be complex. At Canberra Tax Solutions, we specialise in helping sole traders and partnerships understand their tax obligations and opportunities. We'll help assess your eligibility, correctly defer losses where required, and plan ahead to maximise your future deductions.

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