You can deduct hobby expenses up to the amount of your hobby income. Any expenses that exceed the income you made from your hobby are nondeductible personal losses. On the other hand, if you operate a business, your business losses can offset other income on your return. For an activity to be considered a business, it must have a profit motive.
The IRS presumes that you carry on an activity for profit if:
It makes a profit during at least three of the last five years, or
It makes a profit in at least two of the last seven years, and your activities consist primarily of breeding, showing, training, or racing horses.
The IRS considers the following factors when deciding whether your activity is a business or a hobby: No one factor is decisive, and there are factors in addition to those listed that may be considered as well.
Businesslike manner. You keep good records, maintain separate personal and business checking accounts, and have a written business plan.
Marketing efforts. You hire an agent to help you sell your screenplays.
Operating method changes. You change the way you operate the activity to reduce costs or increase revenues. For example, you have a farm and you try alternative crops.
Expertise. You or your advisors have the expertise needed to carry on the activity as a successful business, or you consult with experts.
Time and effort. You leave an occupation to pursue the activity, or you employ others who invest time and effort in the activity.
Expectation of appreciation. Your expected profit from the activity includes the potential increase in the value of your assets.
Success in other activities. You were successful in making a profit in similar activities in the past.
History of income and losses. Your losses are due to circumstances beyond your control, such as drought, disease, fire, theft, weather damage, involuntary conversion, or depressed market conditions. Or your losses occur in the start-up phase of your business.
Occasional profits. You make a profit in some years, and the amount of the profit is high in comparison to your losses.
Dependency on income. You don’t have substantial income or capital from other sources.
You can deduct hobby expenses as an itemized deduction on Schedule A if they exceed 2% of your adjusted gross income.