You Can’t Deduct a Hobby Loss Without a Profit Motive

In a recent case, the Tax Court rejected a writer's claim that the money he made from a book counted as legitimate profit. Julian Block explains the particulars in his latest column.

Jan 8th 2020
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The usual rule is: Lose money in a “transaction entered into for profit,” and you reap a tax deduction.

But those spoilsports at the IRS forbid a deduction when you incur the loss while pursuing your favorite hobby (Code Section 183).

That’s why revenue agents look closely at returns filed by people who offset full-time salaries or other income with losses from writing, painting or other artistic endeavors of dubious profit potential.

The IRS invoked Section 183 in a case involving Maurice Dreicer, who wrote a book about the “perfect steak.” Maurice countered with the claim that to “keep his research up to date,” he had to travel about the world over a period of some 20 years. His itinerary included four visits to London and another four to Paris.

The Tax Court held that Maurice didn’t have a “bona fide expectation of profit” from writing. Though the manuscript was completed, he made only two efforts (both of which were unsuccessful) to get it published, even though the total expenses from his activities as a “writer” during a ten-year period totaled $274,375 while his income from writing was only $15,766. (He had substantial amounts of income from a family trust.)

But the Court of Appeals for the District of Columbia disagreed. It concluded that the Tax Court applied the wrong standard. The application of Code Section 183 depends “not on whether he expected a profit, but instead on whether he engaged in the activity with the objective of making a profit.”

The appeals court noted that “[o]ne may embark upon a venture for the sincere purpose of eventually reaping a profit, but in the belief that the probability of financial success is small or even remote. He therefore does not really expect a profit, but nonetheless is willing to take the gamble.”

The appeals court sent the case back to the Tax Court for reconsideration on the basis of Maurice’s profit objective (Dreicer, 665 F.2d 1292). 

The second time around, Maurice’s luck ran out. The Tax Court decided that he flunked the objective test.

The court’s reasoning: A taxpayer’s declaration of a profit motive isn’t the controlling factor. While it’s to be given some weight, greater weight is to be given to the surrounding objective facts.

Therefore, although a reasonable expectation of profit isn’t required, the facts and circumstances must indicate that he entered into the activity, or continued the activity, with the objective of making a profit. The court noted that this wasn’t the case (Dreicer, 78 TC 642).

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 300 and counting). 

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