Is It a Hobby or a Business? Why It Matters for Your Taxes
August 28, 2026
Many people earn money from activities they enjoy, whether it’s photography, crafting, woodworking, blogging, coaching, raising horses, renting out a cabin, or something else.
The IRS may treat that activity as either a business or a hobby (an activity not engaged in for profit), and the difference can have a big impact on your taxes.
This newsletter explains:
How the IRS looks at hobby vs. business
Why it matters for deducting expenses and claiming losses
Practical tips to help support business treatment when appropriate
Why the Hobby vs. business questions matters
The tax law has special "hobby loss" rules. If the IRS decides your activity is a hobby, you generally can’t deduct more expenses than the income it brings in. In other words, you can’t use hobby losses to reduce other income like wages, investment income, or retirement income.
If the activity is a business (engaged in for profit), ordinary and necessary business expenses may be deductible even if they create a loss. Those losses may be used, within other tax limits, to offset your other income.
Because of this, it’s important to understand how the IRS decides what is a hobby and what is a business.
Hobby or business? How the IRS Decides
You do not have to actually show a big profit every year to be treated as a business. Instead, the IRS looks at your intent, are you genuinely trying to make a profit? The decision is based on all the facts and circumstances.
There is also a helpful profit presumption rule:
If you make a profit in at least 3 out of 5 consecutive years, the IRS generally presumes the activity is for profit (a business), unless they can show otherwise.
For horse-related activities (breeding, training, showing, or racing), the presumption is met if there is a profit in 2 out of 7 consecutive years.
Even if you don’t meet this presumption, you can still show that your activity is a business based on the overall facts.
Key Factors the IRS Looks at
The IRS has listed several non‑exclusive factors to decide whether an activity is a business or a hobby. No single factor controls the outcome; they look at the whole picture.
Here are some of the most important factors, translated into plain English:
Businesslike manner – Do you run the activity like a real business?
Examples:
Keeping complete and accurate books and records
Having a separate bank account
Preparing budgets or business plans
Changing methods if you’re losing money (adjusting pricing, marketing, or operations)
Time and effort – How much time and effort do you put into it?
Consistent, substantial time spent, especially when there is little personal or recreational benefit, suggests a business.
Very limited or casual involvement may point to a hobby.
Dependence on income – Do you need this income to pay your bills?
If the activity is a significant source of your livelihood, that favors business treatment.
High income from other sources and using the activity mainly for fun may point to a hobby.
Expertise and professional advice – Do you or your advisers have business knowledge in this area?
Studying accepted business practices and following expert advice supports a profit motive.
History of income or losses – What does your track record look like?
Losses in early years may be normal during a start‑up period.
Ongoing, unexplained losses year after year, with little change in how you operate, may look like a hobby.
Occasional profits and size of profits – Do you ever make a profit?
Occasional or small profits may help if there is a reasonable chance of a substantial profit in the future.
Continuous large losses with only minor profits can be a negative factor.
Appreciation in asset value – Are you expecting profit from your assets increasing in value?
Example: Holding land or other assets that may appreciate significantly can support a profit motive, even if yearly operations show losses.
Personal pleasure or recreation – How much is this about fun versus profit?
Getting enjoyment from an activity doesn’t automatically make it a hobby.
However, if the activity contains substantial recreational or personal elements (for example, drag racing purely for fun, or luxury sailing with little effort to attract paying customers), the IRS may lean toward hobby treatment.
Remember: the IRS looks at all these factors together. You can help your case by documenting how your activity meets as many business‑oriented factors as possible.
How Hobby Loss Rules Limit Deductions
If the IRS decides your activity is not engaged in for profit (a hobby), the tax law strictly limits how much you can deduct. In general, expenses for a hobby activity are deductible only up to the amount of income from that activity.
In addition, for individuals, certain categories of hobby expenses are treated as miscellaneous itemized deductions, which have been restricted or disallowed in recent tax law changes. This can mean that, in practice, many hobby expenses are not deductible at all beyond basic items like property taxes or mortgage interest that would be deductible anyway.
By contrast, if your activity is a business, ordinary and necessary business expenses may be deducted even if they exceed your business income, subject to other limits (such as rules on excess business losses and basis limitations).
Hobby Vs. Business: Simple Comparison
Below is a simplified comparison of how losses and expenses are treated for a hobby versus a business:
Hobby (Not Engaged in for Profit)
Deductible expenses are generally limited to the amount of hobby income.
You cannot use hobby losses to offset wages, investment income, or other income.
Many hobby‑related expenses for individuals fall into categories of itemized deductions that are restricted or disallowed under current law (e.g., taxes, interest, and casualty loss).
These rules apply to individuals, partnerships, S corporations, trusts, and estates; they do not apply to C corporations.
Business (Engaged in for Profit)
Ordinary and necessary business expenses are generally deductible.
Losses may be used, within other limits, to offset other income.
The IRS looks at your intent to make a profit, your records, and how you operate the activity to decide whether you are truly in business.
Practical Steps to Strengthen Your "Business" Position
If you want your activity to be treated as a business, consider doing the following:
Keep good records
Track income and expenses.
Keep receipts, invoices, bank statements, and mileage logs.
Maintain a separate bank account for the activity.
Create a business plan
Prepare budgets, cash‑flow projections, and marketing plans.
Review performance regularly and adjust your operations to improve profitability.
Operate like similar profitable businesses
Charge reasonable prices.
Advertise or promote your services or products.
Seek professional advice when needed.
Document your time and effort
Keep a log of the hours you devote to the activity.
Note business tasks performed (production, marketing, research, customer service).
Show efforts to turn a profit
Monitor results and make changes when losses continue.
Consider whether assets used in the activity may appreciate and document that expectation.
None of these steps guarantees business treatment, but they support the argument that you are genuinely trying to make a profit.
The line between hobby and business can be blurry, and the consequences for your tax return can be significant. The IRS actively reviews deductions from activities that regularly show losses, especially when the taxpayer has substantial income from other sources.
Before you start a new money‑making activity, report losses from an existing activity, or change how you operate your side work, please contact our office. We can help you: evaluate whether your activity is more likely to be treated as a business or a hobby, understand how much of your expenses you can deduct, advise on good record‑keeping and operating practices to support business treatment, and plan ahead so there are no surprises if the IRS asks questions.
We’re here to help.
If you have questions about whether your activity is a hobby or a business, or how the hobby loss rules affect your deductions, please reach out. We’ll review your situation and give you clear, practical guidance tailored to you.