Is it a business or a hobby? The 9 factors courts consider

The IRS often questions whether a particular hobby constitutes a business or if it’s just a hobby. Under the “hobby loss rule,” you can’t deduct expenses in excess of income, so no loss is allowed.

In the latest example, a collector of sports memorabilia claimed losses for his activity, only to strike out in the Tax Court. (Akey, TC Memo 2014-211)

New case: Mr. Akey worked full time as a quality assurance engineer. He also had a side business involving sports-related collectibles that he had started in the 1980s. On his tax returns for the three years in question—2001, 2002 and 2003—Akey claimed substantial losses, including two years in which he showed zero income, zero cost of goods sold and approximately $20,000 in other expenses.

Akey didn’t report any expenses for insuring the collectibles. Nor did he maintain a bank account, inventory system, accounting system or any books and records relating to the sports memorabilia activity. The IRS disallowed the losses.

At trial, Akey testified that he had an honest objective of turning a profit from his collectibles activity. He emphasized that he had learned to grade the condition of sports cards as a means of enhancing his expertise.

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The following nine factors are used by the courts to determine if an activity is a business or a hobby.

  1. The manner in which the taxpayer carries on the activity.
  2. The expertise of the taxpayer or his or her advisors
  3. The time and effort expended by the taxpayer in carrying on the activity.
  4. The expectation that assets used in the activity may appreciate in value.
  5. The success of the taxpayer in carrying on other similar or dissimilar activities.
  6. The taxpayer’s history of income or losses with respect to the activity.
  7. The amount of occasional profits, if any, which are earned by the taxpayer.
  8. The financial status of the taxpayer.
  9. Any elements of personal pleasure or recreation.

Based on its analysis of these factors, the Tax Court sided with the IRS. Mighty Akey had struck out.