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This is the so-called "Hobby Loss Rule" that the IRS frequently uses to disallow deductions for farms, ranches, sports, animal activities, planes adn creative endeavors,
Often the IRS will disallow business losses on the grounds that the activity is not engaged in for profit. Often these deductions can be supported by proper planning, documentation, timing or showing their connection to a profitable business under the Unified Business Doctrine, e.g., a sporting activity used to to promote a profitable business. (See brief below).
We can advise you on how to schedule, structure and document your activity to optimize deductibility and defend your deductions when challenged by the IRS.
In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income. Trade or business activities and activities engaged in for the production of income are activities engaged in for profit.
The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:
An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).
If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.
What are allowable hobby deductions under IRC 183?
If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.
Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. These deductions must be taken in the following order and only to the extent stated in each of three categories:
"The way to succeed in a hobby loss case is to play the bad guy in the feel good sports movie. If you are in it for the love of the game and you lose money, you also lose in Tax Court . . . if they take a picture of you behind the wheel, make sure you are not smiling." Forbes, Contributor Peter J Reilly CPA writing about the 2012 John Sernett sprint racing case. http://www.forbes.com/sites/peterjreilly/2012/12/04/hobby-losses-need-to-convince-tax-court-you-love-money-more-than-the-game/ (Peter, thanks for your great sport movie clips and entertaining articles).
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One Greenway Plaza
Suite 100
Houston, TX 77098
ph: 832-341-4599
fax: 713-561-3692