Do You Qualify for Hobby Loss Deductions?
For many individuals, a personal passion can turn into a money-making endeavor. It makes a big tax difference if the activity is treated as a business or a hobby.
Here's why: When you operate a business, you can claim a tax loss to the extent your annual expenses exceed your income. In fact, it is not unusual to run losses the first few years of operation. You can use a loss from a sideline business to offset other highly taxed income on your personal tax return, such as wages from your full-time job or investment earnings.
On the other hand, if the activity is one in which you are not engaged in for profit
(i.e., it's a hobby), your expenses are deductible only up to the amount of the income received from the activity. In other words, you cannot claim a tax loss. For this purpose, deductions must be claimed against your hobby income in the following order:
(1) expenses that would otherwise be deductible (e.g., taxes, interest or casualty losses), (2) operating expenses other than depreciation and (3) depreciation and other basis adjustment items.
Furthermore, if an activity is classified as a hobby, the expenses must be deducted as miscellaneous expenses. Miscellaneous expenses are deductible only to the extent the annual total exceeds 2% of your AGI. So you may end up with little or no tax benefit from your hobby expenses.
The distinction is often contested in the courts. Although each case is decided on its own merits, the following factors are critical:
*The manner in which the taxpayer carries out the activity.
*The expertise of the taxpayer, or his or her advisers.
*The time and effort expended by the taxpayer in carrying out the activity.
*Expectations that assets used in the activity may appreciate in value.
*The success of the taxpayer in carrying out other similar or dissimilar activities.
*The taxpayer's history of income or losses with respect to the activity.
*The amount of occasional profits, if any, that are earned.
*The financial status of the taxpayer.
*Any elements of personal pleasure or recreation.
No single factor on its own is conclusive. But if the factors are heavily weighted in one direction, it can make or break your case.
Key point: The tax law presumes that an activity is not a hobby if you have shown a profit in any three out of the last five consecutive years. This tax presumption is even more lenient for an activity involving the breeding, training, showing or racing of horses. In that case, the activity is presumed to be a business--not a hobby--if it shows a profit in only two of the last seven consecutive years.
Of course, the IRS can rebut the tax law presumption by offering proof that the activity is actually a hobby. Keep detailed records.
Bottom line: Make sure you are standing on firm ground if you claim hobby loss deductions. A professional tax adviser can provide assistance.
WWW.BLEIFELDCPA.COM
http://www.bleifeldcpa.com/articles/mar_2010_03.htm
Here's why: When you operate a business, you can claim a tax loss to the extent your annual expenses exceed your income. In fact, it is not unusual to run losses the first few years of operation. You can use a loss from a sideline business to offset other highly taxed income on your personal tax return, such as wages from your full-time job or investment earnings.
On the other hand, if the activity is one in which you are not engaged in for profit
(i.e., it's a hobby), your expenses are deductible only up to the amount of the income received from the activity. In other words, you cannot claim a tax loss. For this purpose, deductions must be claimed against your hobby income in the following order:
(1) expenses that would otherwise be deductible (e.g., taxes, interest or casualty losses), (2) operating expenses other than depreciation and (3) depreciation and other basis adjustment items.
Furthermore, if an activity is classified as a hobby, the expenses must be deducted as miscellaneous expenses. Miscellaneous expenses are deductible only to the extent the annual total exceeds 2% of your AGI. So you may end up with little or no tax benefit from your hobby expenses.
The distinction is often contested in the courts. Although each case is decided on its own merits, the following factors are critical:
*The manner in which the taxpayer carries out the activity.
*The expertise of the taxpayer, or his or her advisers.
*The time and effort expended by the taxpayer in carrying out the activity.
*Expectations that assets used in the activity may appreciate in value.
*The success of the taxpayer in carrying out other similar or dissimilar activities.
*The taxpayer's history of income or losses with respect to the activity.
*The amount of occasional profits, if any, that are earned.
*The financial status of the taxpayer.
*Any elements of personal pleasure or recreation.
No single factor on its own is conclusive. But if the factors are heavily weighted in one direction, it can make or break your case.
Key point: The tax law presumes that an activity is not a hobby if you have shown a profit in any three out of the last five consecutive years. This tax presumption is even more lenient for an activity involving the breeding, training, showing or racing of horses. In that case, the activity is presumed to be a business--not a hobby--if it shows a profit in only two of the last seven consecutive years.
Of course, the IRS can rebut the tax law presumption by offering proof that the activity is actually a hobby. Keep detailed records.
Bottom line: Make sure you are standing on firm ground if you claim hobby loss deductions. A professional tax adviser can provide assistance.
WWW.BLEIFELDCPA.COM
http://www.bleifeldcpa.com/articles/mar_2010_03.htm
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