Learn about the hobby loss rule and whether or not your hobby is for profit or in danger of an audit with this IRS.
The Internal Revenue Service reminds taxpayers to follow appropriate guidelines when determining whether an activity is engaged in for profit, such as a business or investment activity, or is engaged in as a hobby.
Internal Revenue Code 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the hobby loss rule.
Taxpayers may need a clearer understanding of what constitutes an activity engaged in for profit and the tax implications of incorrectly treating hobby activities as activities engaged in for profit. This bookkeeping articles educational fact sheet provides information for determining if an activity qualifies as an activity engaged in for profit and what limitations apply if the activity was not engaged in for profit.
In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income. Trade or business structure activities and activities engaged in for the production of income are activities engaged in for profit.
The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:
An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist 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 income tax deduction 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.
If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.
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: