Do you have a side hustle or hobby that you think of as a business?

If you do, are you claiming tax losses on your Form 1040?

If yes, you’ll want to pay careful attention. Why?

Because the IRS may not consider your hobby a business and therefore they would not allow your loss deductions.

In fact, the IRS typically likes to claim that money-losing sideline activities are hobbies rather than businesses.  Hobby tax rules from the IRS are not favorable for taxpayers. And with a recent change enacted in the Tax Cuts and Jobs Act (TCJA), this may get worse in the years to come.

Business & Hobby Tax Rules

In short, if you can show a profit motive for your now-money-losing hobby or side hustle, you can classify that activity as a business for tax purposes and deduct the losses.

Factors that can prove (or disprove) that your hobby is a business include:

  • Conducting the activity in a business-like manner by keeping good records and searching for profit-making strategies.
  • Having expertise in the activity or hiring advisors who do.
  • Spending enough time to justify the notion that the activity is a business and not just a hobby.
  • Expectation of asset appreciation: this is why the IRS will almost never claim that owning rental real estate is a hobby, even when tax losses are incurred year after year.
  • Success in other ventures, which indicates that you have business experience.
  • The history and magnitude of income and losses from the activity: occasional large profits hold more weight than more frequent small profits, and losses caused by unusual events or just plain bad luck are more justifiable than ongoing losses that only a hobbyist would be willing to accept.
  • Your financial status: typically, the wealthy can afford to absorb ongoing losses (which may indicate a hobby) while the not-so-rich cannot usually afford to lose money time and again (which indicates a business).
  • Elements of personal pleasure. For example, breeding racehorses is lots more fun than draining septic tanks, so the IRS is far more likely to claim the former is a hobby if losses start showing up on your tax returns.

Still not sure if this applies to you? Contact us. During your free consultation with David Alfano, you’ll come to learn the best tax practices for your business activities.