What Is a Hobby Loss?

What Is a Hobby Loss?

Let me explain what a hobby loss really means. It's a loss from what you might think is a business, but the IRS sees it as just a recreational hobby. You can't claim or recover that money if the IRS labels it a hobby, because losses aren't allowed beyond the income your hobby generates. Unlike a real business, these expenses aren't deductible.

Key Takeaways

Remember, a hobby loss is any loss from business activities the IRS considers hobbies. They define a hobby as something you do for pleasure, not profit. You have to report all income, including from hobbies, to the IRS. Before 2018, you could deduct some losses if they didn't exceed the activity's gross income. But the Tax Cuts and Jobs Act wiped out all itemized miscellaneous deductions from 2018 through 2025.

How Hobby Loss Works

Running a business means expecting expenses—you spend to earn. Those necessary costs for your trade, to produce income, or for investments are deductible. If your expenses outpace earnings despite aiming for profit, that loss can offset other income. Any money you make, even from side gigs or fun pursuits that turn profitable, is taxable and must be reported, no matter the source.

Expenses from these that cause a loss are usually deductible, unless the IRS calls it a hobby. The hobby loss rule in the Internal Revenue Code stops what they see as abuse by hobbyists claiming losses. It applies to individuals, S corporations, trusts, estates, and partnerships—but not C corporations. Deductions get limited for non-profit activities.

The IRS uses this rule to block losses from activities not likely for profit. You need to show profit in three out of five straight tax years to prove it's not a hobby. For things like horse racing, it's a bit different. Establish your profit motive with receipts and detailed records—something every taxpayer should do anyway.

Special Considerations

The IRS has a tip sheet to help you tell hobbies from real businesses. Before 2018, if it was a hobby, you could claim itemized deductions on Schedule A of Form 1040. Those deductions followed a specific order: first, personal expenses like mortgage interest and taxes in full; then, things like advertising or wages, but only if income covers the first category; last, depreciation, only if income exceeds the prior deductions.

Tax Cuts and Jobs Act (TCJA)

In 2017, the Tax Cuts and Jobs Act was signed by President Trump, effective from January 1, 2018. This law overhauled taxes, affecting brackets, mortgage deductions, medical expenses, and more—including miscellaneous and itemized deductions. For hobbyists, it means no more claiming expenses or losses to reduce hobby income from 2018 to 2025 tax years.

Avoiding a Hobby Loss

Even with the TCJA eliminating those deductions, know how to dodge the hobby loss rule, especially post-2025. The simplest way is to regularly make a profit. The rule assumes it's for-profit if profitable in three of the last five years—or two of seven for horse activities.

If not, prove your profit motive with these factors: running it businesslike, being an expert, putting in time and effort, creating assets, success in similar things, income/loss history, occasional profits, financial stability, and whether it's for fun or recreation. Fail to profit or prove motive, and it's not a business—the hobby rules apply, and excess expenses aren't deductible.