Is It A Hobby Or Is It A Business? You Make The Call
You just went out and bought a brand new camera. You also built a dark room in your basement and furnished it with all the equipment you need to develop your own pictures. Your ultimate goal is to exhibit and sell your photographs. Is this a hobby or is this a business?
Actually, it doesn't matter what you call it. Rather, it's how you carry on your photographic activity that determines how the IRS will view your work. The IRS's decision is significant. Here's why.
If your activity qualifies as a business, you can deduct the expenses of running that business on your income-tax return, even if you operate at a loss. If your activity does not qualify as a business, it is considered a hobby and you cannot deduct more than what you earn in the activity. The easiest way to qualify your activity as a business is to earn a profit in three out of five years (for breeding, showing, or racing of horses, the test is based on showing a profit in two out of seven years). If you fail that test, your activity will be judged on nine factors to determine whether it's a business or a hobby.
As you read through the nine factorsand the sample federal court cases that followkeep in mind that no single factor will determine the outcome. Nor, for example, do you have to pass five out of nine. All facts and circumstances will be considered. (The sample cases are presented for illustration only.)
1. The manner in which you carry on the activity. A writer's activity was considered a hobby because he never even attempted to have any of his work published.
Your expertise in the activity. A married couple's horse boarding and training activities were considered a business because they both had been raised on ranches and had a great deal of experience in the care of horses.
The time and effort you invest. A pilot's activity was considered a hobby because he couldn't produce his logbooks or other evidence of the time and effort he spent in carrying on his airline operations.
The expectation that the assets used in the activity may appreciate in value. A horse breeder's activity was considered a business because the land on which the horse breeding took place had appreciated in value.
Your success in carrying on other similar or dissimilar activities. The boat racing activity of a general partner in a construction firm was considered a hobby because he had no experience in racing boats.
Your history of income or losses with respect to the activity. A writer's activity was considered a businesseven though she was no longer dependent on her writing for supportbecause she had been recognized as a writer for decades.
The amount of your profits, if any, which are earned. The buying and selling of antiques by a husband and wife was considered a hobby because they were more interested in furnishing their home with antiques than they were with earning a profit.
Your financial status. A schoolteacher's golfing career was considered a business because his golf earnings increased steadily each year and gaining a tax advantage was not a substantial motivation.
The elements of personal pleasure or recreation involved with the activity. A doctor's exotic animal farm was considered a hobby because he admitted that he operated the farm for his own enjoyment and not to make a profit.
One final note: When you begin what you hope will be a business activity, your expectation of profit does not necessarily have to be reasonable. The business' success needn't be a "sure thing;" it can be speculative. You should, however, enter into the activity with good faith and with the intention of making a profit. If you begin the activity solely with the intention of reducing your taxes, chances are good that your activity will be considered a hobby rather than a business.
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