7923. What is the “hobby loss” rule? How does it limit deductions?Nuco Employeercline202014-07-07T22:41:00Z2014-07-07T22:41:00Z38534863Summit Business Media4011570514Site Map/Investments/Special Rules/Limitation on Loss Deductions/Hobby Loss RuleTaxFactsDefaultArticle123301300-00-tf2.xml1300.00;#1957;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2What is the “hobby loss” rule? How does it limit deductions?9200.00000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-14T22:13:39Z7923. What is the “hobby loss” rule? How does it limit deductions?The “hobby loss” rule limits a taxpayer’s deductions if the Service determines that the taxpayer did not enter into the activity with a profit motive or that the taxpayer continued in a money-losing venture after the possibility of profit had lost its importance. Once it is determined that the activity was not profit-motivated, the amount by which deductions exceed income attributable to the activity (e.g., the amount of loss attributable to the activity) is not deductible.IRC Sec. 183. Thus, the taxpayer can deduct amounts that are deductible without regard to any profit motive (such as otherwise allowable interest, certain taxes, and casualty losses) and expenses that are allowable for activities engaged in for profit, to the extent that gross income attributable to the activity exceeds the deductions allowed without regard to profit motive. Planning Point: The deductibility of that latter category may turn out to be limited in a particular case, however, because the deduction will be a miscellaneous itemized deduction. Miscellaneous itemized deductions are taken into account only to the extent that, in the aggregate, they exceed 2 percent of the taxpayer’s adjusted gross income. IRC Sec. 67. These deduction limitations apply to an activity continued without a profit motive from the time when the nature of the activity changed.Whether an activity is engaged in for profit is determined based upon all relevant facts and circumstances.Treas. Reg. §1.183-2(b). Some factors that will be considered in determining whether or not the activity is profit-motivated include: (1) whether the activity is conducted in a businesslike manner; (2) the qualifications of the taxpayer or the taxpayer’s advisors; (3) the amount of time and effort spent by the taxpayer or whether the taxpayer’s agents and employees are competent to carry on the activity (the taxpayer need not personally manage the operation); (4) the potential for appreciation of the venture’s assets; (5) the taxpayer’s history with similar or dissimilar programs; (6) the taxpayer’s success or failure with the particular activity; (7) the amount of occasional profits in relation to losses and to the amount of the taxpayer’s investment; (8) the taxpayer’s financial status, whether he or she can benefit from losses, and whether the taxpayer’s main source of income is from some other activity; (9) elements of personal pleasure or recreation he or she derives from the activity.A “reasonable” expectation of profit is not required, as when the probability of loss is much greater than the probability of gain.Dreicer v. Comm., 78 TC 642 (1982), aff’d. without op. 702 F.2d 1205 (1983). However, the taxpayer must engage in the activity with a genuine profit motive.Fox v. Comm., 80 TC 972 (1983). All facts and circumstances are taken into consideration, but greater weight is given to objective facts than to the parties’ mere statements of their intent.Engdahl v. Comm., 72 TC 659 (1979).Deductions permitted by the hobby loss rule are determined and allowed according to the following sequence: (1) amounts allowable under other IRC provisions without regard to whether the activity is profit-motivated (but other IRC provisions limiting the amount of these deductions would apply, such as limitations imposed on deductions for interest payments under IRC Section 163(d)); (2) to the extent that the gross income attributable to the activity exceeds deductions allowable under (1) above, amounts that would be allowed if the activity were engaged in for profit and that do not result in basis adjustments; (3) to the extent that the gross income attributable to the activity exceeds deductions allowable under (1) and (2) above, amounts that would be allowed if the activity were engaged in for profit and that result in basis adjustments, such as depreciation, partially worthless bad debts, and the disallowed portion of a casualty loss.IRC Sec. 183(b); Treas. Reg. §1.183-1(b).Although IRC Section 183 addresses only the activities of individuals and S corporations, both the Service and Tax Court have taken the position that it also applies to partnerships.Rev. Rul. 77-320, 1977-2 CB 78; Silberman v. Comm., TC Memo 1983-782. The rule is applied at the partnership level and is reflected in the partner’s distributive shares.Rev. Rul. 77-320, above.If the gross income from the activity (determined without regard to profit motive) exceeds deductions for three or more taxable years in a period of five consecutive taxable years, the activity is presumed to be conducted for profit. (The net operating loss deduction is not taken into account as a deduction for this purpose.)IRC Sec. 183(d). However, the Service is not prevented from attempting to rebut the presumption.Dunn v. Comm., 70 TC 715 (1978), nonacq. at 1979 AOD LEXIS 25 (IRS 1979).The taxpayer may elect to postpone a determination of whether the presumption applies. The election postpones a profit determination until after the close of the fifth taxable year of the activity, so the Service will not try to limit deductions until the end of that year. Generally, the election must be made within three years after the due date (without regard to extensions) of the return for the first year of the activity.Temp. Treas. Reg. §12.9. However, making the election extends the statutory period for assessment of deficiency until two years after the due date (without extensions) for filing the return for the fifth year.IRC Sec. 183(e).If an electing taxpayer dies, the five year presumption period ends, even if profits are realized by the taxpayer’s estate in winding up the activity. As the estate is a separate entity from the taxpayer, the estate’s profits are not to be taken into consideration with regard to the for profit presumption in connection with the taxpayer’s activity in years prior to his or her death.Rev. Rul. 79-204, 1979-2 CB 111. The two year extension period for the statutory assessment of any deficiency begins to run from the time for filing a return for the year of death if death occurs during the five year period.TAM 8718001.