What Qualifies as Hobby Expenses on My Tax Return?
By definition, a hobby is something you do for pleasure, and the Internal Revenue Service doesn't let you exempt income from taxation because you spent it on pleasurable pursuits. This isn't to say hobby expenses are never deductible, however. The catch is whether your hobby actually earns you a little money – and, if so, how much.
If your hobby is stamp collecting and all you ever do is buy stamps without ever selling one, your costs are not deductible as a hobby expense. Your hobby hasn't brought in any income. On the other hand, if your hobby is showing horses and you win cash prizes or others pay you for your expertise, the costs you incur may be deductible. They’re limited, however, to the amount of money you actually earn from your hobby. If your hobby reaps $2,500 in income, you can only deduct up to $2,500 of your expenses.
Even if your hobby earns money, you must still meet other requirements to qualify for deducting your expenses. Your hobby must turn a profit three years out of the last five. If it doesn't, you'll have to prove to the IRS that you're engaging in the hobby – and spending income on it – for the express purpose of making money. The IRS calls this its "factors and circumstance test." You can pass if you do things such as keep expense and income records, just as you would if you were conducting a business; if you spend time trying to turn your hobby into a money-making enterprise; and if you can demonstrate that you or your household relies on the money your hobby brings in.
Claiming the Deduction
If you're eligible to claim your hobby expenses on your tax return, it's a twofold process. You also have to claim and pay taxes on the income your hobby brought in. The income appears on Line 21 of your Form 1040 as "other income." You then have to deduct your costs by itemizing them on Schedule A. Qualifying expenses typically include anything you spend that's directly related to your hobby, as long as they're necessary and reasonable. Even if your hobby earns more than you spent, you can only deduct costs that exceed 2 percent of your adjusted gross income. For example, if 2 percent of your AGI is $800, and if you spent $1,200 on your hobby, you can only deduct $400 – the amount over and above 2 percent of your AGI.
If you spend considerable money on your hobby and it brings income into your household, you might be better off filing your taxes as a sole proprietor. This option avoids the requirement that your expenses must exceed 2 percent of your AGI. It also eliminates the rule that you must show a profit in at least two out of five years or convince the IRS that you're pursuing the hobby because you want to make money at it. You can elect this option by completing and filing Schedule C with your tax return instead of itemizing. Schedule C computes what your business brought in, what you spend on it, and the difference – either a negative or positive number – appears on Line 12 of your 1040 as your business income or loss. If you choose this option and your business loses money, the loss offsets the amount of earned income you report and on which you must pay taxes.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.