When Does a Hobby Become a Business?

Many people enjoy hobbies that are also a source of income. From painting and pottery to scrapbooking and photography, these activities can be sources of both fun and finances. If you start to make money from a hobby, you will need to report that income on your tax return. Until 2018, certain hobby expenses were deductible from your taxable income. However, due to the suspension of miscellaneous itemized deductions, the tax law no longer permits the deduction of these hobby expenses. However, if you operate a business rather than a hobby, the law does allow the deduction of certain related expenses. Which begs the question: At what point does your hobby turn into a business?

Hobby or Business?

If someone has a business, they operate it to make a profit. In contrast, people engage in a hobby for sport or recreation. Nevertheless, many businesses grow out of someone’s passion for an activity they initially did for fun. To decide whether a hobby has become a business, consider the nine factors the IRS will use to make the determination.. (“Yes” answers indicate that the activity might be a business.)

• Do you carry on the activity in a businesslike manner and maintain complete and accurate books and records?
• Does the time and effort you put into the activity indicate that you intend to make it profitable?
• Do you depend on income from the activity for your livelihood?
• Are your losses (if any) due to circumstances beyond your control? Or are these losses normal in the startup phase of your type of business?
• Have you changed your methods of operation in an attempt to improve profitability?
• Do you or your advisors have the knowledge needed to carry on the activity as a successful business?
• Have you been successful at making a profit from similar activities in the past?
• Does the activity make a profit in some years, and if so, how much?
• Can you expect to make a future profit from the appreciation of the assets used in the activity?

Don’t Try This at Home

There’s no one answer to the nine questions above that will be determinative on its own. In making the distinction between a hobby and a business activity, the IRS will consider these factors generally, taking into account all facts and circumstances. Furthermore, there is a potential for you to fall within a safe harbor under Section 183(d), guaranteeing that the activity qualifies as a business. If you question whether your hobby activity has grown to the point that it has become a business, it’s time to consult your CRI advisor about how best to treat the income and expenses for tax purposes.