Hobby Losses, written by Robert W. Wood of Wood & Porter, describes the operation of §183, which is intended to prevent taxpayers from converting nondeductible personal expenses into deductible business expenses. 

This Portfolio explores the §183 “hobby loss” rule, under which a taxpayer's deduction for expenses incurred in an activity not engaged in for profit is limited to the income generated by the activity.  

The regulations under §183 contain a list of factors for determining profit intent. These factors, which are based on case law, are intended to provide an objective means of determining the taxpayer's subjective intent. 

Section 183 imposes a “tier system” for deducting expenses in cases in which the potential deductions exceed the allowable deductions. First tier deductions are items, such as real estate taxes, that are deductible without regard to business use or profit motive. Second tier deductions are out-of-pocket expenses attributable to the activity or home business use. Third tier deductions are items, such as depreciation, which affect the basis of property. 

Specific topics found in this Portfolio include 

• an overview of §183, its legislative history, and the §183 disallowance of hobby losses 
• relevant factors in determining profit intent and the manner in which the taxpayer carries on the activity 
• the effect of the §67 floor under miscellaneous itemized deductions and the §68 overall limit on itemized deductions 

Hobby Losses allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents
  
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and moreAlternative approaches to both common and unique tax scenarios

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which covers every federal tax topic with expert, in-depth analysis, and offers commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.

Detailed Analysis

I. Introduction

A. Overview of § 183

B. Legislative History

II. Section 183 Disallowance of Hobby Losses

A. Losses Attributable to Activities Not Engaged in for Profit Disallowed

1. Profit Intent Requirement

2. Subjective Intent Versus Objective Intent

3. Reasonable Intent Versus Good Faith Intent

4. Degree of Taxpayer's Profit Intent

5. What Constitutes a Profit

a. Unrealized Asset Appreciation

b. Before-Tax or After-Tax Profits

6. Time When Profit Intent Is Determined

7. Profit Intent May Be Determined by Entire Economic Relationship

B. Taxpayers Subject to § 183 Hobby Loss Rules

C. Presumption of Profit Intent

1. Special Rule for Horse Owners

2. Election to Defer Determination of Profit Presumption

3. Effect of Profit Presumption

D. Section 183 Disallowance of Hobby Losses Must Be Applied to Each Activity

1. Segregation of Separate Activities

2. Allocation of Income and Expenses to Separate Activities

E. Relevant Factors in Determining Profit Intent

1. Manner in Which the Taxpayer Carries on the Activity

a. Businesslike Manner

b. Adequate Records

c. Changes in Operating Methods

2. Expertise of the Taxpayer or Advisors

a. Consultation with Experts

b. Reliance on Appraisals and Other Data

3. Time and Effort Expended by the Taxpayer in Carrying on the Activity

4. Expectation that Assets Used in the Activity May Appreciate in Value

5. Taxpayer's Success in Carrying on Other Similar or Dissimilar Activities

6. Taxpayer's History of Income or Losses with Respect to the Activity

a. Startup Losses

b. Fortuitous Circumstances

7. Profits Actually Earned and Possibility of Ultimate Profit

8. Taxpayer's Financial Status

9. Elements of Personal Pleasure or Recreation

a. Personal Motives

b. Recreational Facilities

10. Miscellaneous Factors

F. Deductions Allowed Under § 183: the “Tier System”

1. Tier One - Otherwise Allowable Deductions: Taxes, Casualty Losses, Certain Interest, etc.

2. Tier Two - Operating Expenses Less Than Gross Income

3. Tier Three - Depreciation Less Than Gross Income

4. Examples of Deductions Allowed Under § 183

a. Example 1

b. Example 2

G. Interplay with § 280A Disallowance of Losses Attributable to Business Use of a Home

H. Interplay with § 469 Passive Activity Limits

I. Conversion of Principal Residence to Rental Property Prior to Sale

J. Effect of § 67 Floor Under Miscellaneous Itemized Deductions and § 68 Overall Limit on Itemized Deductions

K. Interplay with § 465 At-Risk Limits

L. Avoiding § 183 Disallowance of Hobby Losses

Working Papers

Table of Worksheets

Worksheet 1 Committee Reports Excerpts on § 183 - Activities Not Engaged in For Profit

Worksheet 2 Completed Form 5213, Sample § 183(e) Election to Postpone Determination of Whether Presumption Applies that an Activity is Engaged in For Profit

Bibliography