Hobby or Business? Avoid IRS Hobby Loss Rules and Maximize Tax Deductions
Hobby or Business? How to Avoid the IRS Hobby Loss Rules
Hey, Want to Turn Your Passion into a Paycheck?
Let’s face it—we've all daydreamed about turning that hobby we love into a money-making gig. Whether it's fishing, crafting, photography, or coaching, what could be better than doing what you love and getting paid for it? But here’s the thing: the IRS has its own thoughts on what counts as a business versus just a hobby—and if you don’t play it right, you could miss out on some serious tax benefits.
So, What Are These "Hobby Loss Rules" Anyway?
Basically, the IRS doesn’t want people writing off their fun weekend activities as business expenses unless they’re actually trying to make money. If they decide your passion project is just a hobby, you can only deduct expenses up to the amount of income it makes. Translation: if you're spending more than you're making, those losses won’t help your tax situation.
Why You Really Don’t Want the IRS to Say You’re Just Having Fun
If the IRS pegs your hustle as a hobby, you're out of luck when it comes to deducting the full expenses. And let’s be real—in the early days of launching anything new, you’re probably not making a ton of cash. So you definitely want the freedom to deduct those startup costs.
Two Simple Ways to Stay on the IRS’s Good Side
1. Show a Profit in 3 of 5 Years
One easy way to prove you’re legit is by turning a profit at least three years out of five. If you can do that, the IRS is likely to agree that you're running a business.
2. Prove You’re In It to Win It
If you’re not quite profitable yet, don’t sweat it. You can still qualify as a business if you show you're really trying to make it work. That means acting like a business owner and not just someone with an expensive hobby.
How to Show the IRS You Mean Business
Want to prove you’ve got a real profit motive? Here’s what the IRS and the courts are looking at:
Do You Run It Like a Real Business?
Keep records, track income and expenses, have a business plan—basically, treat it like you would any legit operation.
Do You Know Your Stuff?
Either be knowledgeable about what you’re doing or work with people who are. Learning from experts helps, too.
Are You Putting in the Work?
If you’re dedicating real time and energy, that shows commitment.
Will Your Equipment or Assets Gain Value?
If what you’re using could go up in value (like real estate or collectibles), that helps prove it's more than a casual pursuit.
Have You Had Success Before?
If you’ve made money in similar ventures, that’s a big plus.
What's Your Track Record?
If you’ve got losses, it’s okay—as long as they make sense. Just be ready to explain why.
Do You Ever Make a Profit?
Even an occasional payday helps support your case.
Does the Income Matter to You?
If you’re relying on the money, the IRS is more likely to see it as a business.
Is It Just for Fun?
Let’s be honest—if it looks like you're just having a blast and don’t care about the money, the IRS might call your bluff.
A Real-World Example: Fishing for Profits
One of my clients loved fishing. So, he started a website, wrote a guide on catching fish, and linked to affiliate products for his favorite lures and tackle. He ran it like a business—tracked income, optimized his site, and focused on turning a profit. That passion project? Totally legit in the eyes of the IRS.
Why This Matters for Everyday Entrepreneurs
Whether you're selling candles, offering coaching, or flipping thrift finds online, it’s all about how you set things up. Treat it like a business from day one, and you’ll open the door to awesome tax benefits and real growth potential.
Quick Tips to Keep You in the Clear
Separate personal and business finances
Keep clean, organized records
Update your business plan as you grow
Get advice from a tax pro who knows their stuff
The Bottom Line
Turning your hobby into a business is an amazing adventure. Just remember—it takes a bit of strategy and structure to get the IRS on board. Show them you’re serious, and you can score the deductions, the freedom, and the lifestyle you’ve been dreaming about.
Certified as a Tax Advisor By:
Mark Kohler
Mark J. Kohler, senior partner at KKOS Lawyers and co-founder of Directed IRA, has over 25 years of experience helping entrepreneurs achieve financial freedom. Through YouTube, books, and live trainings, he breaks down complex strategies into simple, actionable steps. His Main Street Certified Tax Advisor Program now equips CPAs and agents to share these insights with clients.
