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Is it a Business or a Hobby?


Determination if it’s a Business or a Hobby

The taxpayers should follow appropriate guidelines when determining whether an activity is a business or a hobby, an activity not engaged in for profit.

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business.

  • An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business.
  • A necessary expense is one that is appropriate for the business. Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

In order to make this determination, you should consider the following factors:

  • Does the time and effort put into the activity indicate an intention to make a profit?
  • Do you depend on income from the activity?
  • If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
  • Have you changed methods of operation to improve profitability?
  • Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
  • Have you made a profit in similar activities in the past?
  • Will the activity make a profit in some years?
  • Can you expect to make a profit in the future from the appreciation of assets used in the activity?

It is presumed that activity is carried on for profit if:

  • The entity makes a profit during at least three of the last five tax years, including the current year
  • At least two of the last seven years, activities consisted of primarily of breeding, showing, training or racing horses.

If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.


Deductions for hobby activities

Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of three categories:

  • Deductions you may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.
  • Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
  • Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.
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