Hobby losses 

The IRS distinguishes between activities taxpayers engage in for profit, such as a business or investment activity, and those considered hobbies, limiting deducations that can be claimed for so-called hobby losses.

Hobby losses, claimed by individual taxpayers, are deductible only to the extent of income generated from that particular activity (i.e., losses from not for profit activities cannot be used to offset other income). However, if profits result in three of the five consecutive tax years ending with the current year in question, the activity is presumed to be profit driven and not a hobby. 

A gray area exists when losses do occur but the intent of the activity is questioned. Reg. §1.183-2(b) provides nine factors for evaluating whether profit is not the overall motivating factor in the activity:

1. Businesslike Manner - The taxpayer should keep appropriate books and records.
2. Expertise and Consultation - The taxpayer should have the required knowledge to carry on the venture.
3. Time and Effort - The taxpayer should devote enough time and effort to substantiate a serious venture.
4. Appreciation in Value - The taxpayer's assets used in the activity are expected to appreciate in value which would recoup prior losses.
5. Success in Prior Activities - This factor looks at the taxpayer's prior entrepreneurial record.
6. History of Profits and Losses - Taxpayer's history is examined and extended losses much be explained. Any irregular circumstances can be explained and effort shown to correct them.
7. Occasional Profits - Looks at the history of profits in the activity and determines if future profits can be expected.
8. Taxpayer's Financial Situation - The tax regulations follow a pattern of lower wealth taxpayers having more incentive to engage in profitable activities. Also, higher wealth taxpayers may be more willing to spend more on unprofitable activities to receive greater tax cuts.
9. Elements of Recreation or Personal Pleasure - Implies an interaction between the time and effort spent on an activity and personal pleasure resulting in activities in which personal pleasure is less apparent may be more profit driven.

Case law shows that no single factor is superior when determining the motivating factor in an activity.  Also, there is no majority or supermajority rule that a taxpayer must win or lose a certain amount of factors. The factors are a guideline, hence the gray area of hobby losses.

Please contact your SS&G representative with questions.