Love what you do, and...

We've all heard the quote, "Love what you do, and you'll never work a day in your life." Can you really take something you enjoy and turn it into a business?

We all have hobbies. Sometimes we might be able to make money with our hobby. You must report any income you make from a hobby, and any related expenses are deductible. However, so called "hobby losses" are not deductible. Expenses up to your total income are fine, but no more. What's worse, those deductible expenses are reported on Schedule A as miscellaneous itemized expenses, meaning they are deductible only to the extent they exceed 2% of your adjusted gross income. To be able to deduct expenses beyond your income, you have to be able to demonstrate you are not just reporting a hobby, but that you are actually running a business.

The IRS says, "If you do not carry on your business or investment activity to make a profit, you cannot use a loss from the activity to offset other income. Activities you do as a hobby, or mainly for sport or recreation, are often not entered into for profit." (Publication 535, Business Expenses.) That doesn't mean you can't make a business out of what's fun.

If your activity shows a profit three out of five years the IRS presumes you're in business to make a profit. (The test is two out of seven years if your activity is related to horse breeding, showing, training, or racing.) Here are other factors the IRS considers when determining whether you have a hobby or are running a business.

• You carry on the activity in a businesslike manner.
• The time and effort you put into the activity indicate you intend to make it profitable.
• You depend on the income for your livelihood.
• Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business).
• You change your methods of operation in an attempt to improve profitability.
• You (or your advisors) have the knowledge needed to carry on the activity as a successful business.
• You were successful in making a profit in similar activities in the past.
• You can expect to make a future profit from the appreciation of the assets used in the activity.

The IRS often argues against activities as businesses when an element of pleasure is involved. However, there have been multiple court cases where people have demonstrated they were actually running a business. Some examples of winning taxpayers are:

• a physician that lost about $1,000,000 over several years when raising cattle,
• a musician that showed his music opportunities were growing, 
• a professor attempting to succeed as an artist, and
• a coach who coached more, increasing his opportunities for profit.

​While there are many other winners, there are also losers. Ultimately, to win this fight, you have to demonstrate you are following the steps to run a business, and not just loving your hobby and trying to write off the related expenses.