Kelan Roy CPA .Com

Hobby Loss Rules under IRC Section 183

Back to Tax Services

If you engage in a business with the objective of making a profit, you can generally claim all your proper business deductions. If your business deductions exceed your income for the tax year, you can claim a loss for the year, up to the amount of your taxable income from other activities. Any remaining losses may be carried over into other years.

However, if the IRS deems your business to have no profit motive (an activity not engaged in for profit) your ability to deduct losses is limited to the amount of income generated by the activity. These are the “Hobby Loss Rules” under IRC 183. A “hobby” can not generate a tax loss that can be used to offset other taxable income on your tax return.

Losses incurred by individuals, partnerships and S corporations in connection with a hobby are generally deductible only to the extent of the income produced by the hobby.

Certain types of expenses such as real estate taxes, home mortgage interest, and casualty losses may be deductible on you individual income tax return regardless of whether they are incurred in connection with a hobby. However, these expenses must be used to reduce the amount of the hobby income from which your other hobby expenses can be deducted.

“Hobby Income” is reported as "other income" on your Form 1040, Individual Income Tax Return. “Hobby Expenses” are only deductible if you itemize deductions on your tax return. They are considered "miscellaneous itemized deductions" and you may only deduct the portion of them that, along with any other miscellaneous deductions, exceeds 2 percent of your adjusted gross income. Depending on your particular tax circumstances this can result in all income form the hobby being taxable income with no offsetting deduction for hobby expenses.

IRC SECTION 183 ACTIVITIES NOT ENGAGED IN FOR PROFIT

GENERAL RULE
In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section.

DEDUCTIONS ALLOWABLE
In the case of an activity not engaged in for profit to which subsection (a) applies, there shall be allowed

(1) the deductions which would be allowable under this chapter for the taxable year without regard to whether or not such activity is engaged in for profit, and

(2) a deduction equal to the amount of the deductions which would be allowable under this chapter for the taxable year only if such activity were engaged in for profit, but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1).

ACTIVITY NOT ENGAGED IN FOR PROFIT DEFINED
For purposes of this section, the term "activity not engaged in for profit" means any activity other than one with respect to which deductions are allowable for the taxable year under section 162 or under paragraph (1) or (2) of section 212.

PRESUMPTION
If the gross income derived from an activity for 3 or more of the taxable years in the period of 5 consecutive taxable years which ends with the taxable year exceeds the deductions attributable to such activity (determined without regard to whether or not such activity is engaged in for profit), then, unless the Secretary establishes to the contrary, such activity shall be presumed for purposes of this chapter for such taxable year to be an activity engaged in for profit. In the case of an activity which consists in major part of the breeding, training, showing, or racing of horses, the preceding sentence shall be applied by substituting "2" for "3" and "7" for "5".

Back to Tax Services