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:
- The manner in which the taxpayer carried on the activity.
Are you keeping accurate books and using them to improve your performance?
- The expertise of the taxpayer or his or her advisers.
Are you seeking professional guidance to improve your business practices?
- The time and effort expended by the taxpayer in carrying on the activity.
Are you investing enough time to make the business successful?
- 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?
- The success of the taxpayer in carrying on other similar or dissimilar activities.
Have you gone from being unprofitable to profitable in similar activities?
- 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?
- 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.
- The financial status of the taxpayer.
Do you have other sources of income that are being offset by the activity?
- 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.
MileIQ’s blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.