Hobby Loss Rules

Beasley v. Comm'r, T.C. Summary Opinion 2009-93 (T.C. 2009).

The Tax Court writes an excellent opinion on the profit motive requirement to avoid the loss limitations imposed by section 182.

The Beasley's are from Maryland - based on the facts, probably somewhere near the Chesapeake Bay. During 2003, Mr. Beasley started a charter fishing business, all the while working full-time as an HVAC project manager. Mr. Beasley deducted losses from his charter fishing service on a Schedule C: ($101,085), ($47,296), and ($33,769) respectively during the periods 2003 - 2005.

The IRS denied the loss deductions for his charter fishing service pursuant to section 183(a) and (b)(2). This section limits the amount that can be deducted when the activity is not engaged in for profit. Specifically, deductions cannot exceed the gross income from the activity. This rule is commonly referred to as the Hobby Loss Rule.

The Tax Court walks through the nine-factor test stated in the Regulations for determining whether an activity is engaged in for profit. After applying the facts to each factor the Court decides if the factor favors the IRS or Mr. Beasley. On balance Mr. Beasley loses. Here is a table of the nine-factors and the Court's decision.

As you can see, Mr. Beasley did not win a single factor. I thought the first three factors could have gone either way. Mr. Beasley was hard pressed to win the last six. My point here is not whether Mr. Beasley won but how the Tax Court went about making its decision.

The last thing I want to point out is how much depreciation Mr. Beasley deducted. In total, $105,288 in depreciation over the three-year period. Assuming a 28% marginal tax bracket, Mr. Beasley saves $29,481 in taxes. Compared to his total interest expense on the boat of $22,545 for the same three-year period, Mr. Beasley essentially gets his fishing boat paid for by the Treasury for three years. If Mr. Beasley never makes a taxable profit (because a profit is not his objective), then Treasury never gets its money back. In this context, the rule reflects good tax policy.

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Some types of expenses such as property taxes, home mortgage interest damages and losses may be deductible on your individual tax return regardless of whether they are engaged in a hobby. However, these expenses must be used to reduce the amount of hobby income from which expenses of other hobby can be deducted.