Turning a Hobby Into a Business
Turning a hobby into a post-retirement business is something many people dream of — and many successful businesses have started out as hobbies. Once a hobby qualifies as a business, you may be eligible for favorable tax deductions.
The Internal Revenue Service (IRS) cautions, however, that it’s important to understand the difference between a hobby and a business when filing your tax returns, because different tax rules apply in each scenario.
Determining Business vs. Hobby
How do you know whether your venture qualifies as a business? First and foremost, the IRS says you must pursue the activity with the goal of making a profit. The IRS suggests that the following questions, while not all-inclusive, can help you determine if you’re operating a business:
- Do you depend on income from the activity?
- Have you changed methods of operation to improve profitability?
- Have you made a profit in similar activities in the past?
- Does the time and effort put into the activity indicate an intention to make a profit?
In short, the activity is considered to be a for-profit operation if you’ve made a profit in three of the past five years.
If your venture is deemed a business, the IRS offers a quick reference on deducting business expenses. Some of the business expenses you may be able to deduct include insurance, retirement plans, rent, business use of your car and home, and more.
In its complete guide to deducting business expenses, Publication 535, the IRS states up front that it’s very important to distinguish business expenses from personal expenses, as well as the costs of starting your business (aka capital expenses).
On the other hand, if your venture is not for profit, yet you want to claim expense deductions, the IRS says you’ll need to itemize deductions on your tax return. Most importantly, with a hobby, you cannot claim financial losses from the hobby to offset other income.
Have questions? Speak with a financial adviser or tax professional to learn more about financial implications and tax rules.
Updated November 11, 2014