IRS Hobby Loss Deductions Rules
Under IRC § 162, ordinary and necessary business expenses are generally deductible if they result from a trade or business. Similarly, under § 212, expenses relating to the production of income or to investment activities are also generally deductible.
Hobby Loss GeneralUnder IRC 162, ordinary and necessary business expenses are generally deductible if they result from a trade or business. Similarly, under section 212, expenses relating to the production of income or to investment activities are also generally deductible. Perhaps most notably, a deduction permitted by section 162 or section 212, may be offset against unrelated income if necessary.
The "hobby loss" rules of IRC 183 limit the deductions of taxpayers that relate to activities not engaged in for profit. Under IRC 183, a taxpayer may deduct expenses only to the extent the taxpayer has gross income from the IRC 183 activity during a tax year. The IRS has sometimes used IRC 183 to attack various tax shelter activities. Even if most business deductions are disallowed by IRC 183, it does not apply to deductions that do not require a profit motive, such as deductions for interest and taxes.
IRS Hobby Loss: Taxpayer MotiveThe taxpayer's intent to engage in a activity for profit is essential to enable the taxpayer to take deductions for the activity (including deductions in excess of the revenue from the activity).
The taxpayer's intent is a question of fact.
The threshold inquiry in determining whether an activity is a trade or business or is carried on for the production of income is whether the activity is engaged in for the primary purpose and dominant hope and intent of realizing a profit. Hayden v. Commissioner, 889 F.2d 1548, 1552 (6th Cir. 1989), aff'g, T.C. Memo 1988-310.
The taxpayer has the burden of proof with respect to proving the requisite profit motive.
Profit means economic profit without regard to tax savings.
An activity is engaged in for profit if the taxpayer entertained an actual and honest, even though unreasonable or unrealistic, profit objective in engaging in the activity. Campbell v. Commissioner, 868 F.2d 833, 836 (6th Cir. 1989), aff'g, in part, rev'g in part and rem'g, T.C. Memo 1986-569.
IRS regulation 26 CFR 1.183-2, "Activity not engaged in for profit" https://www.law.cornell.edu/cfr/text/26/1.183-2 sets forth the IRS position on the general requirements for motive and nine (9) relevant factors for determining profit motive:
1. Manner in which the taxpayer carries on the activity.
2. The expertise of the taxpayer or his advisors.
3. The time and effort expended by the taxpayer in carrying on the activity.
4. Expectation that assets used in 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.
8. The financial status of the taxpayer.
9. Elements of personal pleasure or recreation.
IRS audit guidelines provide for examiners to address each of the foregoing nine factors in a Hobby Loss situation. IRC IRC 183: Activities Not Engaged in For Profit (ATG) (Audit Guide Rev. 6/09).