Are you saddled with a hobby loss? — Business Management Daily: Free Reports on Human Resources, Employment Law, Office Management, Office Communication, Office Technology and Small Business Tax Business Management Daily

Are you saddled with a hobby loss?

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in Small Business Tax,Small Business Tax Deduction Strategies

Generally, it is better for taxpayers to label an activity a “business” than a “hobby.” But there’s more than semantics involved.

Strategy: Handle matters in a business-like fashion. This gives you a better chance of standing up to IRS scrutiny.  

If it’s a close call, a tax law presumption may bail you out, especially if you’re a horse racing or breeding enthusiast.

Here’s the whole story: With a business, you can generally deduct your related expenses in full, even if you end up with a tax loss for the year. Conversely, expenses for a hobby can’t exceed the amount of income from the activity. Thus, you can’t claim an overall tax loss for a hobby.

To make matters worse, hobby expenses can only be written off as a miscellaneous itemized deduction item subject to a deduction threshold of 2% of your adjusted gross income (AGI).

  • The courts have relied on the following factors to distinguish a business from a hobby:
  • The manner in which you carry on the activity
  • The expertise possessed by you or your advisors
  • The time and effort you expend in carrying on the activity
  • Any expectations you have that assets used in the activity may appreciate in value
  • Any prior success in other similar activities
  • Your history of income or losses with respect to the activity
  • The amount of profits, if any, that you earn
  • Your financial status
  • Elements of personal pleasure or recreation.

Finally, if you show a profit in any three out of the past five consecutive years, the IRS will presume that the business isn’t a hobby. The presumption is enhanced for an activity involving the breeding, training, showing or racing of horses. In this case, you must show a profit in only two out of the last seven consecutive years.

Tip: The IRS can rebut the presumption by providing evidence the activity is a hobby.

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