You may have dreams of turning your hobby into a profitable business, one that might eventually grow into a successful, full-time business. If you’ve yet to earn a profit, you may wonder if you can still deduct your expenses on your federal income tax return. That depends on whether the IRS views your activity as a business or a hobby. The IRS says that to qualify as a business, your activities must be conducted for the primary purpose of making a profit and be pursued with continuity and regularity.
Other factors the IRS may review to determine if you have a profit-making objective include:
- Is the activity conducted in a business-like manner? For example, do you have a business plan, a separate business bank account, and complete and accurate books and records?
- Whether you and your advisors have the knowledge needed to carry out the activity as a successful business
- How much time and effort you put into the activity
- Whether you depend on income from the activity for your livelihood
- Whether you expect that assets used in your activity will appreciate in value
- Whether you have made a profit from other similar activities in the past
- If you have altered the operations of your activity in order to boost the potential for profits
- Your history of income/loss with respect to the activity
The IRS makes the assumption that an activity qualifies as a business if it shows a profit for three out of the last five years (two out of the last seven years for activities involving breeding, training, showing, or racing horses).
If It Is a Hobby
Even if not operated with a profit motive, hobbies can be a source of income. Anyone who earns income from a hobby must report that income on their tax return. However, unlike business expenses, hobby expenses that were once deductible as miscellaneous itemized expenses are not currently deductible. The deduction for these expenses is not scheduled to return until 2026.
A tax professional can help you determine whether your activity qualifies as a business or should be regarded as a hobby.