losing money on purpose

lexxi · Jan 28, 2009

We have a businessman who generally makes a decent profit in his primary business, which is real estate development or construction.

He also has a side business that is more of a hobby for himself or his wife. Making a profit is not a priority there. If run very efficiently, it might turn a decent profit on a much smaller scale than the main business, but there's no need to run it efficiently and they get their money's worth as long as they break even. Some of the sales would be by credit card and many by cash.

Is it possible that they would prefer not to break even? Would there be any financial advantages to losing money on this side venture? E.g., tax advantages or opportunities to launder money from the main business or from another more profitable but illegal side business?

CasualObserver · Jan 28, 2009

Tax advantage. Losses can be written off. I believe there's a limit though.

On the other hand, defaulting on debt is a tax DISadvantage. If the bad debt is written off by the creditor, the forgiven amount is considered income by the IRS and they expect taxes to be paid on it. Recently there's been talk about forgiving taxes on forgiven corporate debt, but I've no idea if that passed or how large the company has to be to qualify.

If the company is public, he can make money by selling his company's stock short. In layman's terms, it's a bet that the stock will drop and if it does then you win the bet. (Actually, check if that's legal in America. Might violate insider trading laws.)

Let me know if any of that made sense.

Mumut · Jan 28, 2009

In some cases it is called negative gearing. I do it with a couple of investment properties purely for tax-reduction purposes. Also, in business, there is a point of maximum net profit where making more money from improving the sales is counterproductive. I've had that also when I owned a small store in a seaside resort. I naively worked at making it a store for most needs - groceries, take-away food, tropical fish and pet supplies, I bred budgies and sold cages. And it worked. My ideas flourished. But then I had to employ staff, and you have to sell a lot of goldfish to pay the wage of one assistant.

cbenoi1 · Jan 28, 2009

> Is it possible that they would prefer not to break even?

You can lose money from an accounting perspective while still having positive cash flow. A writeoff does exactly that. Take an asset and declare it has lost market value. Businesses do this all the time. They have the choice of having a string of little bad news over several quarters or bite the bullet and do it once so that any upturn in the business fundamentals ends up adding to the bottom line immediately. CEO and Chairman become instant stars, praised for superb turnaround management in Forbes. <sigh>

There might be a political reason for losing money too. For example, for ditching an annoying partner. You depreciate the market value to the point where you can buy the remaining shares for peanuts.

-cb

losing money on purpose

lexxi

bold enough for both those XXs

CasualObserver

Mumut

Well begun is half done...

cbenoi1