If you have an unincorporated side gig, like offering photography services, creating custom art, or selling handmade items online, you might consider it a business and not a hobby. But will the IRS agree? This distinction between business vs hobby is essential for tax purposes.
When expenses from an activity exceed revenues, resulting in a net loss, you might expect to deduct this loss on your personal federal income tax return. However, it’s not that simple. The IRS often categorizes money-losing side activities as hobbies rather than businesses, and the tax rules for hobbies are far less favorable.
How the Tax Cuts and Jobs Act (TCJA) Changed Hobby Tax Rules
Before the TCJA (pre-2018): If the IRS considered an activity a hobby (i.e., not for profit), you still had to report any income from it on your Form 1040. You could deduct some hobby-related expenses, like home mortgage interest and property taxes, as itemized deductions. Other expenses, up to the hobby income amount, could also be deducted but only if they exceeded 2% of your adjusted gross income (AGI).
Under the TCJA (2018-2025): The TCJA removed deductions for miscellaneous itemized expenses previously subject to the 2%-of-AGI threshold, which includes most hobby-related expenses. Now, the only deductions allowed for hobbies are those you’d typically take anyway (such as mortgage interest and property taxes). So, while you still report 100% of hobby income on Form 1040, you cannot offset it with hobby expenses—even if the activity is unprofitable.
Determining if your Activity Qualifies as a Business
With these restrictions, achieving “for-profit business” status is clearly advantageous. The next step is to determine if your activity qualifies as a business or if it will be considered a hobby by the IRS.
Two safe-harbor rules help establish if an activity qualifies as a for-profit business:
An activity is presumed to be a business if it generates a profit in at least three out of every five years. Losses in other years can be deducted as business losses.
For activities involving horse racing, breeding, training, or showing, the threshold is two profitable years within a seven-year span.
If you don’t meet either safe-harbor rule, you may still be able to deduct losses by showing a genuine intent to make a profit. Factors that can help demonstrate this intent include:
Conducting the activity in a business-like manner and keeping thorough records.
Having expertise in the field or consulting with knowledgeable advisors.
Dedicating sufficient time to the activity, which supports its classification as a business.
Expecting the assets involved to increase in value.
Having prior business successes, indicating business acumen.
Showing that any losses are due to unusual circumstances, rather than consistent, hobby-like losses.
The presence of wealth, which might suggest that ongoing losses are more tolerable and may indicate a hobby.
If the activity involves personal enjoyment, it could be seen as a hobby.
Don’t be Discouraged
The good news is that, over the years, the U.S. Tax Court has recognized several enjoyable activities as legitimate business ventures rather than hobbies for tax purposes. Examples are:
Horse Breeding and Racing: This activity is often questioned due to its high costs and the pleasure some derive from it, but it has been accepted as a business if the taxpayer shows a consistent effort to make a profit.
Yacht Chartering: The Tax Court has accepted yacht chartering as a business venture, provided the taxpayer can prove efforts to turn a profit through active marketing, client acquisition, and proper bookkeeping.
Winemaking and Vineyards: Small-scale wineries and vineyards have also been recognized as legitimate businesses, even if they have personal appeal, as long as there’s evidence of business planning, marketing, and professional advice.
Photography: While photography can be a hobby, individuals who take substantial steps to earn income from it—like marketing services, investing in equipment, and showing profit intent—may be classified as running a business.
Writing and Art: Many writers and artists who actively market their work, maintain records, and seek income from their creations have been deemed business operators rather than hobbyists.
In each case, the court looks for genuine profit intent, a structured approach to earning income, and proper documentation to strengthen your case. We can assist you in creating this documentation to support your position. Schedule a meeting with one of our Tax Consultants to begin.
If you’re interested in turning your hobby into a business, complete the Business Formation form on our website or set up a FREE 30-min consultation meeting to get started.