Hobby Loss Rule
The Hobby Loss Rule refers to IRS regulations that determine whether an activity is considered a business or a hobby for tax purposes. If an activity is classified as a hobby, the taxpayer can only deduct expenses up to the amount of income generated from that hobby, limiting any loss deductions.
To qualify as a business, the taxpayer must demonstrate a profit motive, typically by showing that the activity has generated a profit in three out of the last five years. If not, the IRS may classify it as a hobby, which means the taxpayer cannot use losses from the hobby to offset other income.
For example, if an individual sells handmade crafts and incurs $5,000 in expenses but only generates $3,000 in income, the losses cannot be deducted against other income if the activity is deemed a hobby. In contrast, if the same individual can prove that the craft sales are a legitimate business, they could deduct all expenses related to the activity.
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