Hobbies are great. Some reduce stress, others are fun, a few make money and rarely you can find one that has multiple benefits. By all means, find one or more hobbies and dive into them, as they are good for you.

Hobby losses, on the other hand, aren’t great. When you deduct the cost of the hobby on your tax return, unless you have and can prove a for-profit motive with the activity, then expect an IRS audit.

Some of this is common sense. If you sell Juice Plus or Mary Kay to a few friends and earn a few hundred dollars a year to offset some of your costs of being a seller, then that is likely a hobby and the loss on the venture should not be reported.

If you sell Juice Plus, Mary Kay, raise horses, have an Etsy shop or engage in any other activity more seriously, and want to make sure that you can deduct any losses, then plan your venture, and document your efforts, keeping the following factors in mind:

  1. Treat it like a business by maintaining a separate checking account and keeping good books and records.
  2. Provide proof that you have studied best practices of the venture, such as purchasing (and reading) books on the topic or communicating with successful mentors.
  3. Document the time devoted to the activity. A contemporaneous mileage log is helpful to show where you traveled for the venture, but a contemporaneous calendar is even better.
  4. Don’t jump from venture to venture. The IRS wants to see some profits and success from a venture. If you change from Juice Plus to Mary Kay to something else every year or two, then that will hurt your case.
  5. Try to actually earn a profit. Few things make the IRS angrier than seeing a doctor make $200,000 in salary and then the spouse try to offset $100,000 of that income due to losses from a side business. Sometimes losses are unavoidable, especially in the beginning, but there should be a trend towards success with the business. The IRS presumes that an activity is engaged in for a profit if it makes a profit in at least 3 of the past 5 years. Of course, a small profit one year doesn’t quite negate a huge loss the next year, in the IRS’ eyes.
  6. Activities with recreational appeal are handicapped, because the IRS views them as more likely to be hobbies. So running an Etsy shop from home has little recreational appeal compared to running a home gym and having friends pay a little bit to work out with you, or hosting Juice Plus events at your friends’ homes every few months.

There are at least nine IRS factors in the analysis, and hundreds of cases, so please consider the above to be a very brief (i.e., one minute) run down. If you plan on reporting on your tax return any sort of side business that resulted in a loss, then please make sure to consult with a CPA or tax attorney.