Is It a Hobby or Business?
While hobbies can produce income, they often show a loss after you deduct the costs associated with your pastime. In order to start deducting these losses on your tax return, you must establish that you are carrying on your hobby with the motive of making a profit.
If you can't prove you have a profit motive, the IRS views your activity as a hobby, not as a business. Expenses of a hobby can be deducted only up to the amount of income from the hobby. You can't deduct hobby losses from your non-hobby salary or other income.
If you want to start deducting all of your losses, you can establish a profit motive in one of two ways:
Show a Profit
If you demonstrate a profit in three out of five years (two out of seven years for horse activities), the IRS will presume you've got a business and not a hobby. However, you can't simply manipulate deductions and income to create profit years.
Use Business Practices
The other way to demonstrate that you're operating with a profit motive is to conduct your activity in a business-like manner. Get advice from an accountant to assist with keeping accurate books and records. Maintain a separate checking account, advertise your services or products, and get a business phone listing.
If you have losses, try to turn your business around by taking classes, consulting with experts, and changing your methods of operation. Be sure you spend enough time at your activity to demonstrate that you're serious about profits.
Remember, you don't have to earn a profit, but you must try to do so. If you don't have profits in three out of five years, the burden of proof will be on you to show the IRS that this activity is a business and not a hobby.
If you want to turn your hobby into a business, contact us for assistance with the IRS requirements.