Is it a business or a hobby? Well, the answer to that makes a big difference when it comes to tax ramifications.
So….you are in Florida all winter, basking in the glow of the sun. You buy yourself a handy dandy metal detector and you spend 2 hours a day scouring that beach looking for treasures under the sand. While on your treasure search you also pick up all the beautiful shells you happen to see. Sometimes you offer to sell these shells to people trying to relax on the beach. Mostly they decline but every now and then you get $1 or $2 and buy yourself a snowcone to cool off. You earn $28 from your beach sales. Wowwwweeeee!
Once it’s summer. you haul your treasure (and yourself) back to Ohio so you can get out of all that heat and enjoy some rain instead. Occasionally you will get a table at a flea market at some closed down drive-in theatre lot to sell your beautiful shells. You pull in a whopping $237 during the year at those flea markets. Woohoo!!!!! Nice!
Well, you’ve had some expenses too. Your travel costs to go to Florida, your meals while down there, the condo you rented while there, your decorative beaded bag that you kept the shells in and of course, your fancy straw hat to keep the sun out of your face. And don’t forget that sunscreen. You feel entitled to each and every one of those deductions. A total of $2,852 of expenses there. In addition, you had $160 in flea market table fees to pay to get you the opportunity to try to sell the shells.
So here’s the totals:
Sadly, it’s a loss of $3,277
HERE’S THE QUESTION: Can you deduct that $3,277 against your other income, such as wages, on your tax return for the year????
Well, here’s a few things the IRS looks at to decide if it’s a hobby or a bona fide business:
- was there an intention to make a profit (a profit motive)
- is the business carried on in a businesslike manner
- do you keep accurate books for the endeaver
- was the time and effort put into it enough to show you intended to make it profitable
- might you have suffered a loss from this undertaking (was the loss beyond the control of the taxpayer or did it occur in the start up phase of the business)
- does the time & effort put into the activity indicate an intention to make a profit
- does the taxpayer depend on the income from the activity (are you gonna go hungry if those shells don’t sell?)
- has the taxpayer changed methods of operation to improve profitability
- does the taxpayer (and his/her advisors) have the knowledge needed to make this a successful business?
- did you consult with experts
- has the taxpayer made a profit in similar activities in the past
- does the activity make a profit in some years
- can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity
The IRS presumes that an activity is carried on for profit it if makes a profit 3 out of the last 5 years including the current year.
IF they decide the activity is not for profit then losses may not offset other income. Deductions for the hobby are claimed as itemized deductions on Schedule A. Deductions you could have taken anyway, if the hobby income didn’t exist, can be taken in full. These are items like mortgage interest and real estate taxes if it involves a home office. So you aren’t really gaining anything there. Other expenses can only be taken up to the amount of income you had. So the loss cannot offset any other income. And if you aren’t itemizing then you aren’t getting the deductions at all. Income goes on Line 21 of Form 1040 and is taxed.
So, in summary, you better enjoy picking up those seashells and sitting at flea markets cause it isn’t gonna be a tax deduction for you if you have the situation above.
And Peter better watch what he does with those pickled peppers too…..