Episode 146: Hobby Losses, Gambling Wins, and the IRS's Fine Print

Well, I'm going to start out... with a refresher on the hobby loss rules.

This is like you said, this is not a new rule.

This has been around as far as I can remember becoming a CPA 30 years ago.

And what that means is if you are a sole proprietor and you have a business that you report on schedule C of an individual tax return or a farm that you put on schedule F of your personal tax return, if you annually are reporting losses for that activity, the IRS can start to view that as a hobby.

And if it's considered a hobby, you are not allowed to deduct the expenses associated with that activity.

You're supposed to report the income, but not those expenses.

But there's a lot of factors that they look at on this.

There is a safe harbor.

So if three of the previous five years you have shown income, It's less likely the IRS will come in and try to call that a hobby.

Of course, they could, depending on the facts and circumstances, but that's kind of a test there.

And then they look to see, even if you are actively having losses, if you have a business problem, you know, a profit motive that helps and you're truly treating it like a business.

You have separate books and records, business planning.

You're using your expertise, you know, because obviously some startup businesses do report losses for multiple years before they start to turn a profit.

So, you know, there are times that you can argue with the IRS and say, you know, this is definitely not a hobby, but those are just some general rules around it.

Yeah.

And that's good to point out.

I don't, I don't know about you, but I always tell a client if they are gonna go into an audit too, the worst thing you can say is, oh, I just do this business for fun and I'm really not trying to make any money because immediately that's a hobby.

So if you truly have a hobby, that's fine.

But some people just say that out of nervousness and they don't really, you know, mean it, they do really want to make money.

And, um, yeah, so, I mean, I've had to tell some clients over time, like you have to pick up the revenue and you can only write off the expenses to the extent of the revenue.

You're not allowed to take it into a loss.

You know situation, but yeah, and there's I think I read somewhere too that there's like nine something like the IRS and the courts look at nine factors and I didn't know is that exact but like you said history and showing a profit motive and all of that so that is kind of good guidance because maybe when we are sitting down with someone and they're kind of pushing back, we can say, well, here's the factors.

How do you think you would

stand up to that? Sure.

Yeah.