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Hobby Losses (Portfolio 548)

Tax Management Portfolio, Hobby Losses, No. 548-2nd describes the operation of §183, which is intended to prevent taxpayers from converting nondeductible personal expenses into deductible business expenses.

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DESCRIPTION

Tax Management Portfolio, Hobby Losses, No. 548-2nd 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 prior 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.


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AUTHORS

ROBERT W. WOOD
Robert W. Wood is a 1979 graduate of University of Chicago Law School where he earned a Juris Doctor and won the Florence James Adams Prize. He practices law with Wood & Porter in San Francisco, California (www.woodporter.com) where he provides services for domestic and international clients on a variety of state, federal, and international tax matters. Mr. Wood is admitted to practice law in California, New York, Arizona, Washington, Montana, Wyoming, Texas and the District of Columbia. He is also admitted to practice as a Solicitor in England and Wales. Mr. Wood is a tax expert and has been designated by the State Bar of California as a Certified Specialist in Taxation.
Mr. Wood is the author of over 35 books in the field of taxation, and is recognized as a leading authority and commentator. He is particularly well known for his work concerning the taxation of damage awards and settlement payments, and is the author of the leading treatises in this area, Taxation of Damage Awards and Settlement Payments (4th Ed., Tax Institute © 2009), Qualified Settlement Funds and Section 468B (Tax Institute © 2009), and Legal Guide to Independent Contractor Status (4th Ed., Tax Institute © 2007). Mr. Wood is also the founder and Editor-in-Chief of The M&A Tax Report, a national monthly newsletter addressing tax techniques and trends affecting mergers and acquisitions. For a complete list of Mr. Wood's publications, please visit www.woodporter.com.

TABLE OF CONTENTS

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

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