Hobby Loss

Hobby loss is the term associated with funds spent to pursue a recreational activity which is not recouped. These expenses, when paid in connection with a hobby, are deductible only to the extent of income earned by the hobby or recreational activity. A loss is not allowed for expenses in excess of hobby income. 

Expenses are an expected part of running a business. You have to spend money to make money. Expenses which are necessary to carry on a trade or business, incurred to produce income, or paid for investment in the company are deductible. When, despite a profit motive, your overall expenses exceed your earnings, the loss can offset unrelated income. 

A hobbyist may deduct hobby expenses only to the extent of the hobby’s gross income during a particular taxable year. Losses due to activities not engaged in for profit are disallowed, and they do not carry forward to the next taxable year.

The hobby loss rules of the Internal Revenue Code (IRC) §183 attempt to curb perceived loss deduction abuses by hobbyists. The hobby loss rules apply to individuals, S corporations, trusts, estates, and partnerships, but not to C corporations. These rules limit deductions for activities not engaged in for profit. 

The Internal Revenue Service (IRS) warns that it will apply the hobby loss rules to disallow losses of activities it finds likely not to be engaged in for profit. It cited the following actions, among others, writing, movie making, auto racing, horse breeding, yacht chartering, fishing and practicing law. Taxpayers engaged in these activities must establish a profit motive to avoid the hobby loss limitations.

The easiest way to avoid the hobby loss rules is to turn a profit more often than not. The hobby loss rules presume that an activity is for profit if the operation was profitable for three out of the last five years ending with the current taxable year. For actions involving horses, the timeframe is two of the previous seven years.

If the presumption is not met, then the taxpayer must establish a profit motive. The following nine factors define hobby income and losses. 

1. Does the taxpayer, in carrying on the activity, have a businesslike manner
2. Is the taxpayer an expert or an advisor
3. Do they devote the necessary time and effort 
4. Is an appreciable asset created
5. Are there success' in similar activities
6. What is the history of activity income or loss 
7. Have there been occasional profits
8. Is there a stable financial status? 
9. Is this activity undertaken for personal pleasure or recreation

A taxpayer that fails to turn a profit or to establish a profit motive is not engaged in the event for profit. The hobby loss rules will apply. Hobby expenses that fail its three-tier deduction system are not deductible. Hobby expenses that exceed hobby income are disallowed as non-deductible hobby losses.