IRS Tax Tips
August 6, 2007 – STT-2007-13
Business or Hobby? Answer Has Tax Implications
Fishing, Gardening, Golf, Sewing, Woodworking, Horsemanship, Scrap Booking, Stamp and Coin Collecting, etc.
The IRS isn’t trying to spoil your fun but if your favorite activity makes a profit every year or so, there may be tax implications that surprise you.
What is a hobby? Hobbies, also called not-for-profit activities, are those activities that are not pursued for profit. What is a business? Generally, your activity is considered a business if it is carried on with the reasonable expectation of earning a profit.
If you are not sure whether you are running a business or simply enjoying a hobby, here are some of the factors you should consider:
- Do you run the activity in a businesslike manner?
- Does the time and effort you put into the activity indicate an intention to make a profit?
- Do you depend on income from the activity?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
- Have you changed methods of operation to improve profitability?
- Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Can you expect to make a profit in the future from the appreciation of assets used in the activity?
An activity is usually considered a business if it makes a profit during at least three of the last five tax years, including the current year.
An exception is breeding, showing, training or racing horses. Such activity is presumed to be a business if it makes a profit during at least two of the last seven years.
If you are conducting a trade or business you may deduct your ordinary and necessary expenses. An ordinary expense is an expense that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.
Losses from a not-for-profit activity (hobby) may not be used to offset other income. It is possible to claim some deductions for hobby activities as itemized deductions on your Form 1040 income tax return. However, there are special rules and limits to the deductions you can claim, and those deductions may not exceed the gross income from your hobby.