4. Writing Off Your Losses for a Hobby
Let’s say you have a hobby such as jewelry or any other craft making, dog breeding, bookselling, or coin collecting, and you’ve decided to turn it into a small business that’s taking a loss at the moment.
If your business has multiple years of large losses, IRS classifies it as just a hobby. BUT, your audit risk increases considerably if you have many years of hobby losses and a high income from other sources.
Basically, IRS agents are actively hunting those who unfairly deduct hobby losses. So you should be cautious trying to convert a retirement hobby into a profitable venture.
To qualify for a loss deduction, it’s mandatory for you to use a business-like approach when it comes to running your activity. Also, you should be able to prove that you do intend to run a profitable business. If your activity turns profit three out of every five years, the law assumes that you’re doing this to make money, unless the IRS Audit shows otherwise.
The examination becomes more challenging if you can’t meet these requirements. This is because the decision of whether an activity is legally classified as a business or a hobby depends on each taxpayer’s situation and facts.
