If an individual, partnership,
estate, trust, or an S corporation engages in an activity that is not conducted
as a for-profit business, deductions are limited to the amount of income from
the activity. This rule does not apply to corporations, other than S
corporations. If an activity is considered a for-profit business, deductions
can exceed income, allowing the resulting loss to offset other income.
Determination
In determining whether an activity
is a hobby or a business, all facts and circumstances are taken into account.
No one factor can make the determination. The following list is not intended to
be all inclusive.
1) Manner in which the taxpayer carries on the
activity. Factors that may indicate a business include maintaining complete
and accurate books and records, carrying on the activity substantially similar
to other profitable activities of the same nature, and changing operating
methods and techniques to improve profitability.
2) The expertise of the taxpayer or his or her
advisors. Factors that may indicate a business include knowledge of the
taxpayer, or consultation with those who are knowledgeable about a particular
industry, then using that knowledge to try and make a profit.
3) The time and effort expended by the taxpayer
in carrying on the activity. Factors that may indicate a business include
spending a lot of time and effort in the activity, particularly if the activity
does not have substantial personal or recreational aspects. Taking time away from another occupation may
also indicate a profit motive. Spending little time will not be counted against
the taxpayer if qualified employees are hired to carry on the activity.
4) Expectation that assets used in the activity
may appreciate in value. Even if no profit is made from operations, if the
value of land or other assets in the activity appreciate so that an overall
profit is made from a sale, the activity may be considered a business.
5) The success of the taxpayer in carrying on
other similar or dissimilar activities. If the taxpayer was successful in
the past turning an unprofitable venture into a profitable venture, the current
activity may be a business even if it has not yet made a profit.
6) The taxpayer’s history of income or losses
with respect to the activity. Early losses during start-up will not count
against the taxpayer, but continued losses after the customary start-up stage
that are not explainable may indicate a hobby. Losses sustained due to
unforeseen circumstances, such as casualty or thefts beyond the taxpayer’s
control, will not count against the taxpayer. Any series of profitable years
are strong evidence the activity is a business.
7) The amount of occasional profits, if any,
which are earned. The amount of profits in relation to the amount of
losses, and in relation to the taxpayer’s investment in the activity, may
indicate intent. An occasional small profit one year, mixed with large losses
in other years or large taxpayer investments, may indicate the activity is a
hobby. Substantial occasional profits mixed with frequent small losses or
investment may indicate a business. An opportunity to earn substantial ultimate
profits in a highly speculative venture also indicates a profit motive.
8) The financial status of the taxpayer. If
the taxpayer does not have substantial income or capital from other sources,
the taxpayer may have a profit motive. If the taxpayer has substantial income
from other sources, and losses from the activity in question generate
substantial tax benefits, the taxpayer may not have a profit motive.
9) Elements of personal pleasure or recreation.
Where there are recreational or personal elements involved with the activity, a
lack of profits may indicate a hobby. On the other hand, a lack of any appeal
in the activity other than possible profits indicates a profit motive. It is
not necessary that the sole purpose for engaging in an activity is to make a
profit. The availability of other investments that might produce a higher rate
of return will not count against the taxpayer. The fact that a taxpayer derives
personal pleasure in the activity is not sufficient in itself to classify the
activity as a hobby if other factors indicate the activity is a business.
Presumption of Profit
IRS rules state that if an activity
is profitable in three of the last five tax years, including the current year,
the presumption is it is carried on for profit, and the hobby loss limitations
do not apply. If the activity consists primarily of breeding, training,
showing, or racing horses, the IRS will presume it is carried on for profit if
a profit is produced in at least two of the last seven tax years, including the
current year.
Reporting Hobby Income and Expenses
Occasional profits from hobby
activities are not subject to self-employment tax, and losses from hobby
activities cannot be used to offset other income.
