How Do You Distinguish Between a Business and a Hobby?

May 6, 2019 / by Fortis Family Office Tax Team

As you might expect, the IRS distinguishes between legitimate businesses and hobby activities, for the purpose of taxes. If you are legitimately in business, you can deduct the expenses of that business and possibly take a loss if your business isn’t profitable. If you are engaging in a hobby, you cannot deduct expenses to get a loss to offset other income. The IRS calls this the “hobby loss” rule. ¹

Per the IRS, you should consider these factors ²

  • Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
  • Whether the time and effort you put into the activity indicate you intend to make it profitable.
  • Whether you depend on income from the activity for your livelihood.
  • Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
  • Whether you change your methods of operation in an attempt to improve profitability.
  • Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
  • Whether you were successful in making a profit in similar activities in the past.
  • Whether the activity makes a profit in some years and how much profit it makes.
  • Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

It is best practice to follow the IRS guidelines so you can better understand what is considered to be a legitimate business vs a hobby. Keeping track of your business income and expenses throughout the year will help you determine the factors listed above.


¹ https://www.thebalancesmb.com/is-this-business-for-real-or-is-it-a-hobby-397675

² https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/income-expenses

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