January 2, 2022 10:20 pm

Breeding Miniature Donkeys Wasn’t a Hobby

If a business has losses year after year, the IRS may disallow them on the grounds that the owner is engaged in a hobby activity and lacks a profit motive. A finding that an activity is a hobby because there’s no reasonable profit motive means all income from the activity must be reported, but no expenses can be deducted. Sec. 183 limits deductions from hobby activities to the extent of income, but makes them deductible only as miscellaneous itemized deductions subject to the 2%-of-AGI floor. Because this deduction is suspended through 2025, no deductions are allowed for a hobby activity.

In one recent case, a hedge fund manager had a miniature donkey-breeding venture that he started to create income for his adult daughter, but the operation produced losses which were challenged by the IRS. The Tax Court ran through the usual 9 criteria for determining whether there was a profit motive so decide whether the activity was a business rather than a hobby. The court found that the taxpayer had a profit motive and could deduct losses (William R. Huff, TC Memo 2021-140). The taxpayer’s business savvy as a hedge fund manager was noted by the court as a factor in his favor. Other factors demonstrating a profit motive included his extensive research, hiring experts, and “zero personal pleasure” from conducting the activity.

Tax Glossary

Section 457 plan

Deferred compensation plan set up by a state or local government, or tax-exempt organization, which allows tax-free deferrals of salary.

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