Most of us engage in hobbies of some kind, whether it’s collecting Chinese restaurant menus or making birdhouses. At some point, your hobby may start earning you additional income. Later, if the time that you spend on your hobby increases, you may even consider whether it is possible to make a living from your hobby.
There are special rules and limits for the deductions that taxpayers can claim for hobbies. An important characteristic of a business is that you do it to make a profit. In contrast, you participate in a hobby for recreation or pleasure, not to realize any financial profit. If you decide to turn your hobby into a business, an experienced tax professional can provide advice so that you minimize your tax liability and maximize profit.
Are You Making a Profit?
Deductions are not allowable under federal tax law for activities that are conducted primarily as a hobby, sport, or for recreation. The term activity not engaged in for profit is an activity other than one which allows deductions. To determine whether an activity is engaged in for profit, you must reference objective standards and consider all the facts and circumstances of your case.
While you are not required to have a reasonable expectation of making a profit, the facts and circumstances must indicate that you started or continued the activity with the objective of making a profit. In making this determination, you may meet the test for making a profit even if there is only a small chance of realizing a large profit.
What Deductions Are Permitted?
Deductions are allowable for expenses of conducting activities that constitute a trade or business. Expenses incurred in connection with activities engaged in for the production or collection of income are deductible. Deductions are also allowable for managing, conserving, or maintaining property used and held for producing income.
Business or Profit? No One Factor Is Decisive.
The determination of whether an activity is a hobby or business is based on all the facts and circumstances of your situation rather than one specific factor. Thus, you must generally consider several factors in determining whether an activity is a business engaged in making a profit:
- Do you carry on the activity in a businesslike manner and maintain complete and accurate books and records?
- Do you have personal motives for conducting the activity?
- Does the time and effort you expend carrying on the activity show that you intend to make it profitable?
- Do you depend on the income earned from the activity to make a living?
- Are your losses the result of circumstances beyond your control or are these losses normal expenses that are typically incurred when starting this type of business?
- Do you or your advisors have the knowledge necessary to carry on the activity as a successful business enterprise?
- Were you successful in making a profit carrying on similar activities in the past?
- Does the activity make a profit in some years? If so, how much profit does it make?
- Do you expect to make a future profit from the appreciation of the assets used in the activity?
If you answer “Yes” to most of these questions, you may be carrying on a business in your home.
What If My Activity Is a Hobby?
If after a review of all the related facts and circumstances, the IRS would still consider your activity a hobby, you may still deduct ordinary and necessary hobby expenses. An ordinary expense is anything common and accepted for the activity. A necessary expense is appropriate for the activity.
You must itemize deductions on your return to deduct hobby expenses. You can generally only deduct expenses related to a hobby up to the amount of the income that you derive from the hobby. If your expenses from the hobby exceed the income earned, although you have a loss, you may not deduct it from other income.
Talk to a Qualified Tax Professional
If you live in New York or the Tri-State area and have any questions about any tax-related issue, including a home business or hobby, call 212-490-0704 today for a FREE consultation. You can also learn more online here – THE TAX EXPERTS.
