Horses and other hobbies can be a lot of fun and an important aspect of life, but it can be challenging to turn a hobby into a business. Being a professional horse trainer, for example, would allow you to write off expenses related to your activities. This can be a huge financial benefit to those who are recognizing these expenses with their own horses or pastimes. But the IRS doesn’t want people deducting expenses related to hobbies. So, how can you classify it as a business and not be in hot water with the IRS?
Perhaps, the first test of “hobby vs. business” is a profit motive. Do you really try and make money with your horses? Do you take losses each year from your activities? The IRS has said they will presume that an activity is carried on for profit if it makes a profit during at least three of the last five tax years (or two out of the last seven years for horses), but that is a mere guideline and not a rule.
The IRS will also look for other evidence that you are a professional horse trainer or that your activity is a business. These are the nine factors the IRS lists that can be considered to determine whether it is a business engaged in making a profit:
1. Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
2. Whether the time and effort you put into the activity indicates you intend to make it profitable.
3. Whether you depend on income from the activity for your livelihood.
4. Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
5. Whether you change your methods of operation in an attempt to improve profitability.
6. Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
7. Whether you were successful in making a profit in similar activities in the past.
8. Whether the activity makes a profit in some years and how much profit it makes.
9. Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
If the IRS decides your horse is merely a hobby and not a business, all deductions taken in past years may be disallowed, possibly resulting in a hefty tax liability. Consult with a qualified tax advisor regarding your hobby to see if it would qualify as a legitimate business. It will require constant and diligent recordkeeping to show that your love of horses really has translated into a business, but it can be vitally important if the IRS comes knocking.