Under the hobby loss rules you can’t deduct expenses in excess of income, so no loss is allowed. A
recent tax court case (Akey, TC Memo 2014-211) involved a collector of sports memorabilia who also was a full-time quality assurance engineer. On his tax returns he claimed substantial losses, including two years in which he showed zero income, zero costs of goods sold, and approximately $20,000 in other expenses.
The taxpayer failed to insure the collectables, maintain a bank account, had no inventory system, and did not keep accounting records. At the trial the taxpayer testified that he had an honest objective of turning a profit and that he had learned to grade the condition of sports cards as a means of enhancing his expertise.
The tax court uses the following nine factors to determine if the activity is a business or a hobby:
- The manner in which the taxpayer carries on the activity.
- The expertise of the taxpayer or his or her advisors.
- The time and effort expended by the taxpayer in carrying on the activity.
- The expectation that assets used in the activity may appreciate in value.
- The success of the taxpayer in carrying on other similar or dissimilar activities.
- The taxpayer’s history of income or losses with respect to the activity.
- The amount of occasional profits, if any, earned by the taxpayer.
- The financial status of the taxpayer.
- Any elements of personal pleasure or recreation.
Based on its analysis of these factors, the tax court ruled with the IRS and disallowed the losses as non-deductible hobby losses.
When in doubt, check with your tax advisor.