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Hobby loss, part 2: How does the 9-factor test work?

In the first part of this post, on December 27, we provided an introduction to the concept of hobby loss by looking at a recent case example. The case involved a photographer who created and sold stylized digitized images of the American West.

From 2008 to 2010, the endeavor lost money. The photographer tried to take tax deductions for business expenses for those years. The IRS took the position that those decductions were not allowed. The U.S. Tax Court sided with the IRS, applying a 9-factor balancing test.

What sorts of factors does the 9-factor test involve? In this part of the post, we will address that question.

The test is found in the regulations for interpreting Section 183 of the Internal Revenue Code. As with other multi-factor tests in the law, no single factor is determinative. It is necessary to weigh multiple factors to decide whether a given activity should be treated as a profit-seeking business rather than as a hobby.

The distinction between a business and a hobby matters because there are distinct limits on deductions that can be claimed for a hobby. In general, it is only possible to deduct expenses for an activity that is deemed to be a hobby up to the amount of the income you make from it. For business expenses, there is no such limitation.

Several of the factors in the 9-factor test for distinguishing a business from a hobby deal how the activity is carried out. Did you put a lot of time and effort into it? Based on the results you achieved, did you make adjustments to try to make the activity more profitable? Had you been successful in making money in similar activities in the past?

These are some of the questions contained in the 9-factor test.

With so many factors, however, the question of "hobby loss" remains a tricky and ongoing one in tax law. After all, a hobby can be monetarily profitable, and a business can lose money. So the question of profit or loss by no means settles the matter on its own.

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