Hobby Loss Rules

Is it possible that your business is actually just considered a hobby by the IRS?  Is it possible that your hobby is actually a for profit business in the eyes of the IRS?  IRS code section 183 limits deductions that can be claimed when an activity is not actually engaged in for profit.  This is often times referred to as the “hobby loss rule”. 

When you have a business you are generally able to deduct ordinary and necessary expenses needed to engage in your trade or activity in order to produce income.  If you are generating a lot of expenses and little to no income then it is possible the IRS will consider your business to be just a “hobby”.  The following factors may help you determine whether or not your activity is a for profit business.

1.  Do you put enough time and effort into the activity so that it indicates your intention to make a profit?

2.  Do you depend on income from the activity?

3.  Were any losses that were incurred due to circumstances beyond your control or during the start-up phase of your business?

4.  Have you made attempts to improve profitability?

5.  Do you have the necessary knowledge to run a successful business?

6.  Does the activity make a profit in some years?

According to the IRS an activity that has made a profit in at least three of the last five years, including the current year, is a for profit activity.  If your business has never shown a profit or only shows a small profit every few years, then it is very possible that the IRS could disallow some of your business deductions under Section 183. 

If your activity is shown to not be a for profit business then the deductions that will be allowed cannot exceed the gross income of the activity.  Deductions for a hobby are taken on Schedule A (itemized deductions) of your form 1040. 

Please consult your tax advisor if you have questions about whether or not your business is a for profit venture or a hobby.



About the author

Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. Since 2002, he has owned his own small business, Huddleston Tax CPAs. He is a graduate of Washington State University and the University of Washington School of Law.