What Is a Hobby Loss?
The term hobby loss refers to a loss that results from a business deemed to be a recreational activity or hobby by the Internal Revenue Service (IRS). Taxpayers cannot claim and recoup this money when the agency says it is spent while pursuing a hobby. That's because losses aren't allowed for expenses in excess of hobby income. This means these expenses aren't deductible as they are with a business.
Key Takeaways
- A hobby loss refers to any loss incurred while a taxpayer conducts business that the IRS considers a hobby.
- The IRS defines a hobby as any activity undertaken for pleasure rather than for profit.
- Income derived from all sources, including hobbies, must be reported to the IRS.
- Prior to 2018, taxpayers were able to deduct some losses stemming from the activity if they didn't exceed the gross income for the activity.
- The Tax Cuts and Jobs Act eliminated all itemized miscellaneous deductions between the 2018 and 2025 tax years.
How Hobby Loss Works
Expenses are an expected part of running a business—you have to spend money to make money. Expenses that are necessary to carry on a trade or business, incurred to produce income, or paid for investments in your company are deductible. When, despite a profit motive, your overall expenses exceed your earnings, the loss can offset unrelated income.
Any income you earn is taxable and must be claimed, even if it doesn't come from your employer. This includes any part-time and temporary work, side gigs, and recreational pursuits that lead you to make a profit. Expenses related to these activities that result in a loss are generally deductible. That is, of course, unless the IRS considers your activity to be a hobby.
The hobby loss rule of theInternal Revenue Code(IRC) attempts to curb perceived loss deduction abuses by hobbyists. The hobby loss rule applies to individuals, S corporations, trusts, estates, and partnerships, but not to C corporations.Deductions are, therefore, limited for activities not engaged in for profit.
According to the IRS, it applies the hobby loss rule to disallow losses of activities it finds likely not to be engaged in for profit. Profit must be demonstrated for three out of five consecutive tax years. Some activities, such as horse racing, have slightly different requirements. Taxpayers engaged in these activities must establish a profit motive to avoid the hobby loss limitations. Proof of profit motives include receipts and detailed recordkeeping, which is a good idea for every taxpayer in any situation.
The Tax Cuts and Jobs Act eliminated itemized miscellaneous deductions, including hobby losses, until after the 2025 tax year.
Special Considerations
The IRS published a tip sheet to help taxpayers distinguish between hobbies and legitimate business operations. Prior to the 2018 tax year, you were allowed to claim itemized deductions as itemized on Schedule A of Form 1040, assuming you were engaged in a hobby and not a covert or nascent business. The deductions were required to be taken as follows and only to the extent state in the following categories:
- Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
- Deductions that don’t result in an adjustment to the basis of property, such as advertising, insurance premiums, and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
- Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent that gross income for the activity is more than the deductions taken in the first two categories.
Tax Cuts and Jobs Act (TCJA)
In 2017, President Donald Trump signed the Tax Cuts and Jobs Act into law. The 200-page law went into effect on Jan. 1, 2018, and made sweeping changes to the tax law, including changes in the tax bracket, mortgage interest deductions, medical expenses, miscellaneous expenses, and itemized deductions.
So how does this affect hobbyists? Once the TCJA was signed, any expenses or hobby losses that a taxpayer was able to claim to reduce their hobby income in previous tax years are no longer allowed. This applies to tax returns filed between the 2018 and 2025 tax years.
Avoiding a Hobby Loss
Although the TCJA eliminated miscellaneous itemized deductions, it's still important to know how to avoid the hobby loss rule if provisions aren't made after the 2025 tax year. The easiest way to avoid the hobby loss rulesis to frequently turn a profit.The hobby loss rule presumes that an activity is for-profit if the operation is profitable for three out of the previous five years ending with the current taxable year. For actions involving horses, the timeframe istwo of thepreviousseven years.
If the presumption is not met, then the taxpayer must establish a profit motive. The following nine factors define hobby income and losses:
- Does the taxpayer have a businesslike manner while carrying on the activity?
- Is the taxpayer an expert or an adviser?
- Do they devote the necessary time and effort?
- Is anappreciable asset created?
- Are there successes in similar activities?
- What is thehistory of activity income or loss?
- Have there been occasional profits?
- Is there astable financial status?
- Is this activity undertaken for personal pleasure or recreation?
A taxpayer that fails to turn a profit or to establish a profit motive is not engaged in a business.The hobby loss rules will apply.Hobby expensesthat fail its three-tier deduction system are not deductible. Hobby expenses that exceed hobby income are disallowed as non-deductible hobby losses.
