income, your tax return — June 04, 2013

Is Your Hobby a Business to the IRS? Part 1

by Bob Williams

hobby income

It’s great to have a hobby. Now that spring is here, we can devote more time to those activities we really like, and that can help take our minds off the day-to-day grind. And some of us can actually make a few shillings on the side. Whether it’s woodworking, cake-decorating, or even computer repairs, some folks are good enough at their hobbies to actually get paid for it. Sweet!

Now enter the IRS; and they don’t really see a hobby – they see income. So they say you should list hobby income on Line 21 of the Form 1040, Other Income. Seems simple enough. The problem, though, comes when you try to deduct your losses from your hobby. Not so fast. Now you have a wider issue.

You see, the Internal Revenue Service code that governs hobbies – Section 183, Activities Not Engaged in for Profit – limits deductions that you can claim from a hobby. IRC 183 is sometimes called the “hobby loss rule.”

Deducing Your Deductions

Under IRC 183, allowable deductions for a hobby (that means not-for-profit) can’t exceed the gross receipts for the activity.

Deductions should be posted on the Schedule A, Form 1040, but they should be taken in the following order. And the IRS is pretty specific on how much of each deduction you can attribute to your hobby.

Step 1: Deductions for certain personal expenses, such as home mortgage interest or taxes, may be taken in full.

Step 2: Deductions that do not result in an adjustment to the basis of property – advertising, insurance premiums and the like – can be taken next, but only if there’s gross income for the activity left over from Step 1.

Step 3: Deductions that reduce the basis of property, like depreciation and amortization, can be taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two steps.

In other words, if your deductions in Step 1 are equal to the gross income you had for the hobby, you’re done; you can’t take any more deductions on the hobby for the year.

If you’re really serious about deducting all your hobby losses, maybe it really is more of a business. We’ll take a look at your hobby through the eyes of the IRS in our next visit.

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