Hobby or business ? 
4/25/07
IRS audit guide (6/09) IRC ยง 183: Activities Not Engaged in For Profit (ATG)
The IRS issued "hobby loss" Fact Sheet FS-2007-18, April 16, 2007 (deductions for activities not engaged in for profit). See also IRS Publication 535, Business Expenses. Taxpayers may deduct ordinary (common and accepted in the taxpayer's trade or business) and necessary (appropriate for the business) expenses for conducting a trade or business. Generally, an activity qualifies as a business if carried on with the reasonable expectation of earning a profit. Taxpayers should consider the following factors:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Does the taxpayer 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?
- Has the taxpayer changed methods of operation to improve profitability?
- Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
- Has the taxpayer made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?
The IRS presumes that an activity is carried on for profit if it makes a profit during at least 3 of the last 5 tax years, including the current year, and at least 2 of the last 7 years for activities consisting primarily of breeding, showing, training or racing horses. Losses from a not for profit activity may not be used to offset other income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations, but does not apply to corporations other than S corporations.
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 3 categories:
- Deductions that a taxpayer 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.