Business Expense Deductions versus Hobby Expense Deductions

Recent Court Cases between Taxpayers and the IRS

Jack R. Fay, PhD, CPA, and Melvin L. Roush, PhD, CPA

Although the Internal Revenue Code (IRC) provisions concerning a business activity and a hobby activity have not significantly changed, CPAs should still familiarize themselves with best practices. The primary rule on this subject is that if an activity is a business in nature, a net loss (i.e., total related expenses exceed total related revenues) is tax deductible; on the other hand, if an activity is a hobby, a net loss is not tax deductible. Furthermore, the expenses related to a hobby activity (up to the amount of revenues) are deductible only when itemized and must be deducted in a particular order; for example, any related mortgage interest and real estate taxes must be deducted first. There are no carryovers for excess expenses related to a hobby; consequently, any expenses in excess of revenues are lost forever.