Recently I posted two hobby cases (horse breeding) with different results. I have been asked “why the difference?” For tax purposes, a hobby has some very unfavorable consequences to the taxpayer. Net income is always reported, however, a net loss is limited to zero.
Therefore, how do you make sure that your activity is a profit motive and not a hobby? Here are several items to keep in mind:
• Your intent of the operation is to make money, not create a tax loss.
• You must run the operation like a regular business. This means having a separate checking account for the business; do not commingle personal funds together; have letterhead and business cards.
• If the operation runs at a loss for several years, you must be able to document how you will finally make money. In some cases, showing how you have created extra value in the asset when it will be sold will be sufficient, but be ready for an audit if you show too many years of losses.
• A horse farm has a greater chance of being determined as a hobby farm.
• The size of the operation can affect the hobby status. For example, it is fairly hard to argue that a 2 acre garden plot is a farm (however, in some extensive forms of farming, this can be true).
Remember the key point to ask yourself, is this truly an operation being operated like a business, or is it merely intended to create a tax loss? If it is the latter, then it is more difficult to not treat it as a hobby.
