Application Internal Revenue Code section 183

1 application

1.1 not engaged in profit
1.2 deductions otherwise allowable
1.3 section 162 , 212 have applied
1.4 deductions may not exceed amount of corresponding gross income
1.5 practical considerations

application

the hobby loss rule breaks down 4 requirements: not engaged in profit, deductions otherwise allowable, sections 162 , 212 have applied, corresponding gains.

not engaged in profit

section 183(c) defines activity not engaged in profit activity other have expenses allowed trade or business (§ 162) or investment (§ 212).

there presumption activity profit created in § 183(d) 3 out of 5 year rule. gross income activity must exceed deductions activity in 3 out of previous 5 years. if activity presumed activity engaged in profit. taxpayer must show primary, predominant, or principal purpose of creating profit. topic further explored in 26 code of federal regulations § 1.183-2

deductions otherwise allowable

some deductions, such in § 164 allow deduction of taxes, allowable without regard whether activity engaged in profit. these not limited.

section 162 , 212 have applied

on other hand, expenses allowable if trade or business or investment still allowable deduction here, except limited explained below.

deductions may not exceed amount of corresponding gross income

section 183(b)(2) provides taxpayer may deduct amount equal amount of deductions allowable [ . . . ] if such activity engaged in profit, extent gross income derived such activity taxable year exceeds deductions allowable [ . . . ]. provision limits deduction expenses hobby activities amount equal gross income generated same activities.

this means, example, knitter not qualify call knitting trade or business, can deduct expenses of hobby amount gained hobby. cost of yarn , other expenses depreciation on knitting machine may deducted against sale price of scarf sold, not against unrelated income knitter makes @ day job.

practical considerations

for business (activity engaged in profit), income , expenses listed on schedule c (and net income result carries line 12 of form 1040). expenses used, if create net loss. hobby (an activity not engaged in profit), income , expenses listed separately. income included on line 21 of form 1040 (other income). therefore, hobbyist required file long form, form 1040 (as other forms 1040a , 1040ez have no lines include other income ). however, expenses listed on line 23 of schedule (other expenses). leads couple of hidden consequences. firstly, taxpayer must add these expenses other job expenses (as investment expenses , tax preparation costs) , reduce sum 2% of adjusted gross income (agi). portion exceeds 2% of agi deductible. secondly, taxpayer must itemize deductions on schedule a, or hobby expenses not deductible @ all. if taxpayer itemizing deductions, adequate job or investment expenses, hobby expenses deductible.