Key Takeaways
- IRC §183 governs activities not engaged in for profit.
- IRS uses 9-Factor Test to distinguish business from hobby.
- Post-TCJA (Tax Year 2024): hobby expenses = 0% deductible.
- Hobby income: fully taxable, no SE tax.
- Presumption: profit in 3 of 5 years (2 of 7 for horses).
- Form 5213: postpone hobby determination.
Last updated: January 2026
Hobby vs. Business (Profit Motive)
Why This Matters for the Exam
Hobby loss is a classic audit trigger. Know the 9-factor test and the TCJA trap (0% deductions).
Exam Note: For the May 2025 - February 2026 testing window, you are tested on §183 rules as of December 31, 2024 (Tax Year 2024).
Expect at least 3-4 questions on hobby vs. business.
The Core Distinction
| Feature | Trade or Business (§162) | Hobby (§183) |
|---|---|---|
| Primary goal | Profit | Recreation |
| Loss treatment | Deductible (subject to limits) | 0% (disallowed) |
| Income reporting | Schedule C / K-1 | Schedule 1, Line 8j |
| SE Tax | Yes (on net profit) | No |
The 9-Factor Test (Treas. Reg. 1.183-2)
| Factor | Business Indicator |
|---|---|
| 1. Manner of conduct | Professional books, budgets, analysis |
| 2. Expertise | Consults advisors, studies market |
| 3. Time and effort | Significant hours invested |
| 4. Asset appreciation | Land value offsets operating losses |
| 5. Success in other activities | Track record of turning businesses around |
| 6. History of income/losses | Startup losses normal, 15 years = problem |
| 7. Occasional profits | Potential for significant wins |
| 8. Financial status | Not using losses to offset high salary |
| 9. Personal pleasure | Emphasizes drudgery, not fun |
The 3-out-of-5 Presumption
| Activity | Presumption |
|---|---|
| General | Profit in 3 of last 5 years |
| Horses | Profit in 2 of last 7 years |
| Effect | Shifts burden of proof to IRS |
Form 5213
| Purpose | Description |
|---|---|
| Postpone determination | Delay hobby classification |
| Period | Until first 5 (or 7) years complete |
| Benefit | Buy time to turn profit |
The Tax Year 2024 Trap
| Rule | Effect |
|---|---|
| Hobby income | Fully taxable |
| Hobby expenses | 0% deductible (TCJA 2018-2025) |
| Result | Taxed on gross income |
Real-World Scenario
Scenario: Executive sells $1,000 artwork but spends $5,000 on supplies. IRS determines hobby.
- Income: $1,000 (taxable).
- Deductions: $0 (TCJA disallows).
- Result: Taxed on full $1,000.
On the Exam
Expect 3-4 questions on hobby, typically:
- 9-Factor Questions: "What is strongest business indicator?"
- Presumption Questions: "How many profit years for horses?"
- TCJA Questions: "Hobby expenses deductible?"
The key is to remember: 9 factors, no single decisive. 3 of 5 (2 of 7 horses). TCJA = 0% deductions. Hobby income fully taxable, no SE tax.
Test Your Knowledge
Executive: $1,000 art sales, $5,000 supplies. IRS says hobby. Tax effect?
A
B
C
D
Test Your Knowledge
Strongest business indicator under 9-factor test?
A
B
C
D
Test Your Knowledge
Horse breeding presumption requires profit in how many years?
A
B
C
D