Operating Losses: Prove Your Hobby Is a Business
Be ready to prove that your hobby is a business if you want to write off your losses.
If you intend to earn a profit from engaging in your favorite hobby -- a hobby business -- you may be able to deduct your hobby-related expenses or losses from your income and lower your tax bill. But to avoid trouble, be sure your activity qualifies as a true business and pay attention to local business rules.
What is a Hobby Business?
Hobby businesses are usually run from home (renting an office would be too expensive) and are often based on semi-recreational activities near and dear to the owner, thus earning them the nickname "hobby businesses." There are as many types of hobby businesses as there are hobbies. A basement jewelry studio, a jazz band for hire, and an antique refinishing business might all qualify.
Often a person's hobby or sideline business is a labor of love rather than a reliable source of income. This is most often the case when the business owner or freelancer has other means of financial support -- such as a regular job or a working spouse -- that effectively underwrites the microbusiness.
Deducting Hobby Losses From Your Income
An unprofitable business can be a tax shelter. So if you love what you're doing (as is usually the case in a hobby business), it might make sense for you to stick with your business even though it makes little or no money.
If you have another source of income, you may be able to use the losses from your hobby business -- including your expenses and depreciation on assets you purchase -- to offset your other taxable income. Deducting these losses can not only lower the amount of income on which taxes are owed, but also drop you into a lower tax bracket.
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Reza and Kay are married and file a joint tax return. Reza earns $65,000 per year at his job. Kay decides to turn her passion for plants into a business. After spending $10,000 on equipment and permits, she sells $200 worth of plants.
The silver lining for Kay and Reza comes at tax time, when they deduct the $9,800 loss from their joint taxable income of $65,000. By reducing their joint taxable income to $55,200, they not only are taxed on less income, but their tax bracket is reduced from 25% to 15%.
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Of course, most entrepreneurs would much prefer to make money by earning a healthy profit rather than to take tax deductions because their business is losing money. And the savings made possible by a tax shelter do not always justify continuing a marginal or losing business. But the tax savings definitely can make a difference when you're deciding whether or not it's worth it to keep spending money on your hobby.
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