Do you know the difference between a hobby and a for profit business? If you don’t know the answer to this question you should take some time and familiarize yourself with the “hobby loss rules” under Internal Revenue Code Section 183. This code section explains that activities that are not engaged in for profit – are limited in the amount of deductions that can be taken.

The deductions that can be taken for a hobby activity are limited to the amount of income generated by the hobby. Therefore, hobbies cannot generate net operating losses.

Here are some factors that may help you determine if your business is really a hobby:

• Does the time and effort put into the activity indicate an intention to make a profit?
• Do you depend on income from the activity?
• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
• Have you changed methods of operation to improve profitability?
• Do you have the knowledge needed to carry on the activity as a successful business?
• Have you made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

Links:Publication 535, Business Expenses