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A Quick Hobby Loss Refresher: Why These Losses Are Useless (At Least Until 2026)

Posted on Jan. 23, 2023

Today’s post veers slightly from procedure. If one takes seriously the promise that the coming uptick in IRS will fall on those with incomes over $400,000, we might see an increase in hobby loss/ Section 183 cases. When wealthy taxpayers try their hand at boat chartering in the Caribbean, dressage, running a vineyard, or writing a travel guide premised on finding the best sushi in Japan, and the activities generate losses that the taxpayer would like to use to offset other income, the IRS may carefully scrutinize the taxpayer’s profit intent.

As I teach my students, Section 183 is technically a deduction allowance provision. Taxpayers may have some gross income from the hobby. Section 183 allows taxpayers to deduct some of the expenses from the activity, even if the taxpayer does not establish the profit intent to merit the activity qualifying as a trade or business.

If a taxpayer cannot establish the needed profit intent, Section 183 is supposed to allow taxpayers to deduct the expenses associated with the hobby activity to the extent that the hobby has kicked off some income. But for 183, the expenses would be considered personal nondeductible expenses under Section 262. That means that, theoretically at least, as a result of Section 183 taxpayers are not going to have an increase in tax liability due to their likely pleasurable but unprofitable activity. So Section 183 throws a small bone to taxpayers who, but for 183, would face an increase in tax liability from an otherwise personal activity that would not generate any deductible expenses.

Enter the 2021 Tax Court case of Gregory v Commissioner T.C. Memo. 2021-115. I came across it an article on Section 183 by Leila Carney, Entrepreneur or Hobbyist: Turning Losses Into A Win, 110 Practical Tax Strategies 10 (January 2023). And back in 2021 Bryan Camp has a really nice write up of the case in his weekly Tax Prof series, where he provides some helpful historical context for our tax system’s distinction between above the line and below the line deductions.

Gregory involved taxpayers who had a Caribbean-based boat chartering business. Gregory confirms that a taxpayer whose activity is deemed not for profit will not be able to take any deductions from that activity, save expenses (like local taxes) that would otherwise be deductible.

For those still with me here is the roadmap getting to that outcome. The Code does not specifically identify Section 183 as an above the line deduction used in computing AGI. To get to taxable income, taxpayers can elect to take their itemized deductions or take the standard deduction. Section 67 defines itemized deductions as deductions other than (i) those allowable in computing AGI and (ii) the deduction for personal exemptions allowed under Section 151.

Section 67(b) identifies a number of itemized deductions that are not considered miscellaneous itemized deductions (like, for example, home mortgage interest).

Unfortunately, Section 67(b) does not list Section 183 losses in the category of itemized expenses that are not miscellaneous itemized deductions.

Why is that unfortunate? Well, prior to 2018, miscellaneous itemized deductions were deductible only if they were greater than 2% of a taxpayers AGI. And, as part of what is referred to as the Tax Cuts and Jobs Act, from the years 2018-25, the Code suspends deduction of all miscellaneous itemized deductions. Until 2025, all expenses from the 183 hobby activity will be disallowed, (except expenses that would otherwise be deductible), even while income from the activity remains taxable “other income”..

In Gregory, the taxpayer argued that Section 183, as a more specific statutory provision, should in effect preempt Section 67, with the result that the allowance of expenses under 183 means that those expenses could be deducted above the line to establish AGI.

The Tax Court disagreed, finding that the statutes were not in conflict; rather it just “assumes there is conflict between these two provisions of the Code when in fact each provision may be given effect without precluding or otherwise undermining application of the other.”

The bottom line for the Gregorys is not pretty: the income from their boat chartering activities (totaling $342,173 and $313,825 for the respective years at issue) is taxed as “other income,” but the lion’s share of their corresponding expenses ($341,423 and $313,699) are MIDs. (Payments totaling $750 and $126 categorized as taxes.) Then, “because the Gregorys’ total miscellaneous itemized deductions for both years at issue were less than 2 percent of their adjusted gross income (AGI), no deductions for the [boat chartering] expenses (with the exception of the tax expenses) [are] permitted pursuant to section 67(a).”

The Gregorys have appealed this to the 11th Circuit; there was oral argument last week.


A couple of years ago IRS published guidelines for Section 183 audits. Given the temporary disallowance of all miscellaneous itemized deductions, the stakes are even higher when a taxpayer is deemed to not have the requisite profit intent. I suspect that we may see more of these fact-intensive cases in the years to come.

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