The IRS has rules that limit the deductibility of expenses and losses
from a hobby or activity not engaged in for profit. If the IRS
determines that an activity is not profit-driven, deductions from the
activity are limited to the amount of income the activity generates.
Losses from such activities cannot be used to offset other income, such
as salary or investments.
In being able to deduct a net loss from a business –whether it is a business that normally has ups and downs or one in which the unexpected might occur– you must be prepared to show that an activity that generates deductions is a business from which you intend to profit. It is not necessary that the activity actually earns a profit, so long as a profit is one of the motives for participating in the activity.
The IRS assumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year, or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses. Otherwise, the IRS applies non-exclusive tests and factors to the surrounding facts to judge whether activities are more like a business with a profit motive, or are for personal satisfaction. Under IRS rules and judicial precedent, the following nine factors are considered in determining whether an activity is engaged in for profit: