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Can You Deduct Your Expenses From A Hobby?

Manasa Reddigari

No, tax reform makes deducting hobby expenses nearly impossible.

Is this a hobby or a business?

It's important to know if the IRS classifies your activity as a hobby or a business. If your hobby is now a full-fledged business, you should take valuable business deductions.

Generally, the definition of business is a venture whose primary purpose is to make a profit. If your motive is not primarily for profit but rather, for fun, sport or recreation, it is considered a hobby.

How are expenses and losses treated?

Much of the confusion for taxpayers occurs when they classify their hobby as a small business because it generates some income. Essentially, the difference between a hobby and a business is not about profit and loss. It's all about intent.

The following questions can help you make the distinction between a hobby and a business:

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  1. The manner in which the taxpayer carried on the activity.
    Are you keeping accurate books and using them to improve your performance?
  2. The expertise of the taxpayer or his or her advisers.
    Are you seeking professional guidance to improve your business practices?
  3. The time and effort expended by the taxpayer in carrying on the activity.
    Are you investing enough time to make the business successful?
  4. The expectation that the assets used in the activity may appreciate in value.
    Are you planning to generate a profit from the appreciation of assets?
  5. The success of the taxpayer in carrying on other similar or dissimilar activities.
    Have you gone from being unprofitable to profitable in similar activities?
  6. The taxpayer's history of income or loss with respect to the activity.
    Have you been profitable in at least three of the past five years for most businesses?
  7. The amount of occasional profits, if any, which are earned.
    Even a small profit earned every year provides strong evidence of a business rather than a hobby.
  8. The financial status of the taxpayer.
    Do you have other sources of income that are being offset by the activity?
  9. Elements of personal pleasure or recreation.
    Does the activity have significant personal elements (indicates a hobby)?

If the IRS classifies it as a hobby, you can't get the same set of deductions as a business. Still, you can often deduct some hobby expenses.

Hobby expense deduction in the past

Before the new tax reform rules, you would have to prove your hobby as a business by passing not one but nine tests. It mattered because the outcome of the hobby-business tests had serious tax implications.

Under the prior tax law, you could potentially deduct hobby expenses up to the amount your hobby made money. You'd treat those expenses as a miscellaneous itemized deduction that you could only deduct if it exceeded 2 percent of your AGI.

Unfortunately, tax reform removed this deduction.

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