Class notes
Tax 3300 Hobby Income/Loss Notes
- Course
- Federal Taxation 3300
- Institution
- Baruch College
Detailed notes on Income/loss.
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HOBBY INCOME/LOSSWhat is it? An activity that has both a personal and profit seeking motive. Examples include raising
horses and operating a farm used as a weekend residence.
What is the Purpose of Classifying an Activity as a Hobby? Personal losses are not deductible. Losses
attributable to profit-seeking activities may be deducted and used to offset a taxpayer’s other income.
Activities that have both personal and profit-seeking motives are classified as hobbies, and the tax law
limits the deductibility of hobby losses.
If an individual can show that an activity has been conducted with the intent to earn a profit,
losses from the activity are fully deductible (and reported, along with any income, on Schedule
C).
A purely personal expense is not deductible. I.e a car not used for business.
What are the Tax Consequences of an Activity Being Classified as a Hobby?
The income and deductions from a hobby are reported separately on the tax return (i.e. they are not
netted). The net revenue for the hobby is always reported as other income [line 8 of Schedule 1 (Form
1040)]. The deductions (and how they are reported) are limited in ways that are not favorable to the
taxpayer.
Income. If an activity is a hobby, any gross income (sales less cost of goods sold) generated is
taxable.
Expenses. There are specific rules for deducting all other expense (other than cost of goods
sold). Other expenses are deductible only to the extent of the gross income from the hobby.
Additionally, these expenses must be deducted in the following order:
1) Amounts deductible under other Code sections without regard to the nature of the
activity, such as property taxes and home mortgage interest.
2) Amounts deductible under other Code sections if the activity had been engaged in for
profit, but only if those amounts do not affect adjusted basis (e.g., maintenance and
utilities).
3) Amounts for depreciation, amortization, and depletion. Treas. Reg. §1.183-1(b)
Meaning the expenses that are deductible regardless of whether they are business expenses
(taxes and mortgage interest) are deducted first when determining the gross income limit. This
is not favorable to the taxpayer because they crowd out the expenses that are only deductible to
the extent they will reduce gross income (i.e. categories 2 and 3). However, even worse, the
TCJCA made miscellaneous expenses non-deductible until 2025. Since the tax code categorizes
#2 and 3 as miscellaneous itemized deductions, they are not deductible at all – even against
gross income from the hobby.
EXAMPLE Stefan, the vice president of an oil company, has AGI of $80,000. He decides to pursue
painting in his spare time. He uses a home studio comprising 10% of the home’s square footage.
During 2021, Stefan sold paintings for $5,660 and incurs the following expenses on Stefan’s
entire house:
1
, Frames $ 2,800
Art Supplies $ 900
Home Studio
o Property Tax $ 2,000
o Mortgage int $10,000
o Maintenance Utilities $4,600
o Depreciation on 10% of home $ 500
Gross Income = $1,960 (Sales ($5,660)– Cost of Goods Sold, the frames and art supplies
($3,700)). Assuming the activity is a hobby, S’s deductible expenses would be (i) $1,200 for
Property Tax and Mortgage Interest (this is 10% of the $12,000). The remaining gross income is
$760. The second tier of expenses is maintenance and utilities and are deductible as an itemized
deduction in the amount of $460 (10% of $4,600). The remaining gross income is $300 The third
tier of expenses is the depreciation. This is deductible as an itemized deduction to the extent of
$300 (the remaining gross income). Until 2025, itemized deductions are NOT deductible at all.
Summary. S will include $1,960 in income, increasing AGI (i.e. to $81,960 assuming no other
items). S will be able to deduct the $1,200 as an itemized deduction (but note that these items
are deductible regardless of whether they are incurred in a business, hobby or personal. The
remaining expenses (even those under the Gross Income) are not deductible from 2018-2025.
These items may never be deducted. Because the property taxes and home mortgage interest are
deductible even without the hobby and no deduction is allowed for the other expenses, Stefan is
taxed on his $1,960 of gross income. Presumably in 2026, the $460 of maintenance and utilities
and $300 of depreciation will be deductible as a miscellaneous itemized deduction subject to a
2% floor. The remaining $200 of depreciation will not be deductible because it is in excess of GI.
How Do you Determine if an Activity is Classified as a Hobby?
General Rule. The hobby loss rules apply only if the activity is not engaged in for profit. (In
which case, hobby expenses are deductible only to the extent of hobby income). This is a facts
and circumstances test.
Nine Factors to Consider. Treas. Reg. §1.183-2(b)(1)-(9). The Regulations indicate that the
following nine factors should be considered in determining whether an activity is profit-seeking
or is a hobby.
1. Whether the activity is conducted in a businesslike manner.
2. The expertise of the taxpayers or their advisers.
3. The time and effort expended.
4. The expectation that the assets of the activity will appreciate in value.
5. The taxpayer’s previous success in conducting similar activities.
6. The history of income or losses from the activity.
7. The relationship of profits earned to losses incurred.
8. The financial status of the taxpayer (e.g., if the taxpayer does not have substantial
amounts of other income, this may indicate that the activity is engaged in for profit).
9. Elements of personal pleasure or recreation in the activity.
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