It can be great fun to take a hobby you’re passionate about and use it to generate income. But if you plan to take tax deductions for your hobby expenses, be aware that the IRS has strict rules about business deductions.
If your activities constitute a business, then your expenses, including depreciation, may be tax-deductible. As a hobby, these expenses are subject to limitations. Business losses are tax-deductible and can be used to offset other taxable income. Hobby losses cannot.
The IRS defines a hobby as an activity not engaged in for profit. So how can you prove you’re trying to run a money-making business?
One test you’re probably familiar with is the general rule of earning a profit in three of the past five years. If your business has more income than deductions in three of five consecutive taxable years, the IRS generally accepts that you have a profit motive. (The time frame is two years in seven for certain horse-related activities.)
Unable to meet that test? Additional factors play a role as well. Here are some of the determining factors.
If you hope to deduct any losses resulting from a sideline business, be certain that you are doing all that is necessary to meet the requirements of running the activity in a business-like manner. For more details or assistance, give us a call.
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