Hobby Loss Rule (IRC 183)

Under the Hobby Loss Rule, losses from for-profit endeavors are treated differently than hobbies that may involve some profit. In many cases, the line between a hobby and a for-profit activity is not clear. There are certain requirements for showing that an activity is for a business purpose and not simply a hobby. Tax law changes as part of the 2018 Tax Cuts and Jobs Act (TCJA) also eliminated deduction options for many hobbies. If you have any questions about the Hobby Loss Rule, contact Juda Gabaie at Gabaie & Associates, LLC for help. 

What is the Hobby Loss Rule? 

Under the Internal Revenue Code § 183, if an activity is not engaged in for profit, no deduction attributable to such activity shall be allowed, except as provided. Many people are engaged in an activity as an individual, or corporation, that they treat as a business. However, the IRS may disagree and claim the business is actually a hobby and cannot take advantage of the beneficial tax treatment. 

There are some “safe harbors” that taxpayers can use where their activity will presumptively be treated as a for-profit business. However, the IRS can overcome this presumption. There are a number of relevant factors used to evaluate whether an activity is engaged in for profit. 

Hobby Loss Safe Harbors

There are a couple of safe harbors under IRC § 183(d). There is a presumption that an activity is engaged in for profit where: 

• The gross income derived from the activity for three or more of the taxable years in a period of five consecutive taxable years exceeds the deductions attributable to the activity; or
• Where the activity consists in major part of the breeding, training, showing, or racing of horses, income from the activity exceeds the deductions in two or more of the taxable years in a period of seven consecutive taxable years.

For Profit Factors

In determining whether an activity is presumed to be operated for profit, the IRS may look at nine non-exclusive factors, including: 

1. The manner in which the taxpayer carried on the activity, 
2. The expertise of the taxpayer or his or her advisers, 
3. The time and effort expended by the taxpayer in carrying on the activity, 
4. The expectation that the assets used in the 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 loss with respect to the activity, 
7. The amount of occasional profits, if any, which are earned, 
8. The financial status of the taxpayer, and 
9. Elements of personal pleasure or recreation. 

Pre-TCJA Hobby Deductions 

Before the TCJA, the expenses for many hobbies were deductible as long as they did not exceed the profits of the hobby. 

For example, a coin collector buys and sells rare coins. Sometimes the collector makes a profit but sometimes the collector loses money over the year. If the coin collector bought a bunch of coins that turned out to be fake, the collector may have been able to deduct those expenses from the profitable sales, even if the activity was determined to be a hobby. After the TCJA, the collector would have to report the profit as income but could not deduct the losses. 

Questions About the Hobby Loss Rule

If you received a notice from the IRS claiming that your business activity is really a hobby or have questions about the Hobby Loss Rule, contact Gabaie & Associates, LLC for a free consultation. You can contact Juda Gabaie online or call (410) 862-2198 for help with your IRS or Maryland tax issues.