Question
How do you distinguish between a business and a hobby?
Answer
In making the distinction between a hobby or business activity, take into account all facts and circumstances with respect to the activity. A hobby activity is done mainly for recreation or pleasure. No one factor alone is decisive. You must generally consider these factors in determining whether an activity is a business engaged in making a profit:
- Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
Note that if your sole proprietorship business shows a loss in more than 2 out of 5 years, it vastly increases your chances of being audited. And, it’s presumed to be a hobby: the burden of proof moves to you to prove it’s a business instead of it being up to the IRS to prove it’s a hobby.
Activity not engaged in for profit defined:
https://www.ecfr.gov/cgi-bin/text-idx?SID=2c8c515e70d79f99314ab3dd0c63c6f4&mc=true&node=se26.4.1_1183_62&rgn=div8
Other Sources:
https://www.irs.gov/faqs/small-business-self-employed-other-business/income-expenses/income-expenses