Think of your hobby as a puzzle. To secure the pieces of the puzzle that allow you to deduct your losses, you need to demonstrate a profit motive. In other words, you must establish that your now-money-losing hobby is indeed a business for tax purposes.
To minimize your exposure, consider these 8 factors that can prove (or disprove) your intent:
- Conducting the activity business-likely by maintaining meticulous records and actively seeking profit-making strategies.
- Possessing expertise in the activity or enlisting the guidance of knowledgeable advisors.
- Allocating sufficient time to justify classifying the activity as a business rather than a hobby.
- Anticipating asset appreciation, which explains why the IRS rarely considers owning rental real estate a hobby, even in the face of recurring tax losses.
- Demonstrating success in other ventures, which reflects your business acumen.
- Assessing the history and magnitude of income and losses from the activity. Occasional significant profits carry more weight than frequent small profits. At the same time, losses resulting from unusual events or unfortunate circumstances are more justifiable than ongoing losses that only a hobbyist would accept.
- Considering your financial status. Individuals deemed “rich” may be able to absorb ongoing losses, potentially indicating a hobby. On the other hand, ordinary folks typically seek to generate income, suggesting a business motive.
- Acknowledging elements of personal pleasure. Breeding racehorses, for example, tends to be more enjoyable than working with septic tanks.
Act now to establish your sideline activity as a legitimate business, not a hobby.
August 31 is the deadline!