Business or Hobby

Many people are confused about their hobbies being businesses. For many they have a hobby that they spend a lot of their disposable income on and would like to be able to recoup some of their losses by converting the hobby into a business. These are exactly the types of business ventures that the IRS is likely to scrutinize. Examples of these types of businesses include: Auto Racing, Horse Racing, Animal Breeding, and many types of pyramid businesses.

Now that doesn’t mean that these types of activities can not be a business instead of a hobby. The main factor is the initial intent of the business. Did the owner start the business with the intention of making a profit or was profit a secondary motive. As a general rule if a business makes a profit in three out of five consecutive years, two out of seven when related to horses, the activity is considered to be a legitimate business. However the IRS can still challenge the activity. Proper record keeping is of paramount importance when trying to defend an activity as a business.

When determining if an activity is a hobby or business there are many factors that will be considered. A single factor is not decisive of and buy itself. The main factors considered by the IRS when challenging an activity are:

1. “You carry on the activity in a business-like manner,
2. The time and effort you put into the activity indicate you intend to make it profitable,
3. You depend on income from the activity for your livelihood,
4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
5. You change your methods of operation in an attempt to improve profitability,
6. You, or your advisors, have the knowledge needed to carry on the activity as a successful business,
7. You were successful in making a profit in similar activities in the past,
8. The activity makes a profit in some years and the amount of profit it makes, and
9. You can expect to make a future profit from the appreciation of the assets used in the activity. “IRS Pub 535

As always you should consult with a tax professional when considering these matters to help you decide whether your activity is a business or just a hobby.

The information contained on this site should in no way be considered to be professional advice in the form of either tax, accounting, or legal service or consultation. You should always consult with a professional familiar with your individual circumstances before making any specific decisions related to accounting, tax, or legal matters.