Turning Your Hobby into a Business

You’ve loved dogs all your life so you decide to start a dog breeding and training business. Turning your hobby into a business can provide tax benefits if you do it right. But it can create a big tax headache if you do it wrong.
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One of the main benefits of turning your hobby into a business is that you can deduct all your qualified business expenses, even if it results in a loss. However, if you don’t properly transition your hobby into a business in the eyes of the IRS, you could be waving a red flag that reads, “Audit Me!” The agency uses several criteria to distinguish whether an activity is a hobby or a business. Check the chart below to see how your activity measures up.

​The Business-Versus-Hobby Test

BUSINESS	versus	HOBBY
You have a reasonable expectation of making a profit.	Profit Motive	You may sell occasionally, but making money is not your main goal.
You invest significant personal time and effort. You depend on the resulting income.	Effort and Income	It's something you do in your free time; you make the bulk of your money elsewhere.
Your expenses are ordinary and necessary to run your business.	Reasonable Expenses	Your expenses are driven by your personal preferences and are not strictly necessary.
You have a track record in this industry, and/or a history of making profits.	Background	You don't have professional training in the field and have rarely or never turned a profit.
You have multiple customers or professional clients.	Customers	You have a few customers, mainly relatives and friends.
You keep professional records, including a separate checkbook and balance sheet; you have business cards, stationary, and a branded business website.	Professionalism	You don't keep strict professional records of your activities; you don't have a formal business website or business cards.

Honest Assessment

If your dog breeding business (or any other activity) falls under any of the “hobby” categories on the right side of the chart, consider what you can do to meet the business-like criteria on the left side. The more your activity resembles the left side, the less likely you are to be challenged by the IRS.

On the other hand, if you determine that you’re really engaged in a hobby, there are still some tax benefits to be had. You can treat hobby expenses as a miscellaneous itemized deduction on a tax return, but generally not more than hobby income. They can be used to reduce taxable income if they and other miscellaneous expenses surpass two percent of your adjusted gross income.
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If you need help to ensure you meet the IRS’s criteria for business-like activity, reach out to schedule an appointment.