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How to decipher between a hobby and a business

You love knitting. In fact, you are so good that you have become known for your little baby bonnet creations. Women in your neighborhood have even paid you to generate custom infant apparel. Therefore, you think the following: "My knitting has become a business, and therefore, any financial losses incurred will be deductible in full against my taxes." Unfortunately, your idea of a trade or business may be incorrect in the eyes of the IRS. Instead, you may just have a crafty hobby. If that is the case, expenses from the activity are limited to profit derived from the particular pastime.

The good news is that Section 183 of the U.S. Code helps clarify whether an activity is a true trade or a hobby. The law looks at nine different factors:

  • The manner in which you carry out the activity.
  • Your expertise.
  • The time and effort you have put into the activity.
  • Whether you plan to generate profits from the activity through asset appreciation.
  • Your financial success in carrying out similar activities.
  • Your history of income or losses with respect to the interest.
  • The frequency of profits derived from the activity.
  • Your overall financial status.
  • Whether the activity is for pleasure.

Depending on your answers, your specific activity may be deemed a hobby -- not a business. For example, if you do not knit every month, you may be involved in a pastime and not a real trade.

If you believe that your activity is a business and the losses should offset your financial responsibility under the tax code, it may help to speak with a legal professional. A lawyer can help you examine your financial doings in the context of Section 183.

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