Hobby losses are not deductible on your federal tax return. The Tax Cuts and Jobs Act eliminated the deduction for hobby expenses starting in 2018, and the One Big Beautiful Bill Act of 2025 made that elimination permanent. Hobby income is fully taxable, but the costs of earning it produce zero tax relief. If your woodworking side project brings in $3,000 and costs $5,000 in materials and tools, you owe tax on the full $3,000 with no offset for any of those expenses.
Why the Deduction Disappeared
Before 2018, hobbyists could deduct their expenses up to the amount of hobby income earned, provided those expenses cleared a floor of 2% of adjusted gross income. Those deductions lived inside a broad category called miscellaneous itemized deductions. The Tax Cuts and Jobs Act suspended that entire category for tax years 2018 through 2025, and the One Big Beautiful Bill Act permanently repealed it by adding a new subsection to the tax code.1Office of the Law Revision Counsel. 26 U.S.C. 67 – 2-Percent Floor on Miscellaneous Itemized Deductions
The hobby loss rule itself, Section 183 of the Internal Revenue Code, is still on the books. It says that when an activity is not engaged in for profit, deductions are limited to the income the activity produces.2Office of the Law Revision Counsel. 26 U.S.C. 183 – Activities Not Engaged in for Profit The problem is the plumbing. Those limited deductions used to reach the return through the miscellaneous itemized deduction category, and with that category permanently gone, there is no path onto the return at all. The statute technically caps hobby deductions at hobby income. In practice, the cap is now zero.
That holds whether the hobby is selling handmade jewelry, flipping vintage furniture, or breeding show dogs. Every dollar earned is taxable. Every dollar spent is a personal expense the tax code ignores.
How to Report Hobby Income
All hobby income has to be reported, no matter the amount. It goes on Schedule 1 of Form 1040, line 8j, labeled “Activity not engaged in for profit income.”3Internal Revenue Service. 2025 Schedule 1 (Form 1040) From there it flows into your adjusted gross income the same way wages or interest do. This is different from a business, which uses Schedule C to calculate a net profit or loss by subtracting expenses from revenue.
One quiet upside of hobby treatment: you generally do not owe self-employment tax on hobby income, because the activity is not a trade or business. Self-employment tax adds 15.3% on top of income tax, so avoiding it takes some sting out of losing the expense deduction.
The IRS cross-references your return against information reported by payment platforms and clients. Payment apps and online marketplaces must issue Form 1099-K when total payments exceed $20,000 across more than 200 transactions in a calendar year.4Internal Revenue Service. General Instructions for Certain Information Returns (2026) Clients who pay you $600 or more may issue a 1099-NEC. If a form lands at the IRS and the matching income is missing from your return, expect an automated notice. And even when no information return is filed, you still have to report the income.
When the Activity Is Actually a Business
The deduction ban applies to hobbies. If your activity is genuinely a business, you report it on Schedule C, and losses there can offset wages and other income. So the real question, if you are losing money, is which side of the line your activity sits on.
The IRS applies nine factors from the federal regulations to decide whether you actually intend to make a profit or are enjoying a personal pastime.5eCFR. 26 CFR 1.183-2 – Activity Not Engaged in for Profit Defined No single factor decides the case; the IRS weighs them together based on the facts.6Internal Revenue Service. Know the Difference Between a Hobby and a Business The factors ask whether you run the activity in a businesslike manner with proper books and a separate bank account, whether you or your advisors have expertise in the field, how much time and effort you put in, whether the assets used in the activity are expected to appreciate, whether you have made similar activities profitable before, what your income and loss history looks like, whether occasional profits are large enough to suggest a real profit motive, whether you have substantial income from other sources that could absorb chronic losses, and how much personal pleasure the activity involves.
The financial status factor trips up a lot of high-income taxpayers. A surgeon running a horse farm at a perpetual loss reads very differently to an auditor than someone whose entire livelihood depends on that farm. Wealth is not the problem. The question the auditor is asking is why someone would keep pouring money into an activity that never pays for itself unless the personal enjoyment is the return.
The Profit Presumption
Section 183 offers a safe harbor. If your activity produces a net profit in at least three out of the last five consecutive tax years, including the current year, the law presumes you are operating for profit. When it applies, the IRS carries the burden of proving the activity is a hobby, rather than you having to prove it is a business. Horse breeding, training, showing, and racing get a more lenient version: a profit in two of the last seven consecutive tax years.2Office of the Law Revision Counsel. 26 U.S.C. 183 – Activities Not Engaged in for Profit
The presumption is helpful but not bulletproof. It is rebuttable, so the IRS can still argue you are running a hobby if other evidence points that way. Missing the threshold does not automatically make your activity a hobby either. The nine factors still control.
What Happens If the IRS Reclassifies Your Business as a Hobby
Claiming Schedule C losses on an activity the IRS later decides is a hobby sets off a chain reaction. The disallowed expenses raise your taxable income for every year in question. You owe back taxes on the difference, plus interest compounding from the original due date of each return.
On top of that, the IRS can impose a 20% accuracy-related penalty on the underpayment. The penalty applies when the underpayment results from negligence or a substantial understatement of tax. For individuals, a substantial understatement exists when the underpayment exceeds the greater of 10% of the tax that should have been shown on the return or $5,000.7Internal Revenue Service. Accuracy-Related Penalty A side venture with $15,000 in disallowed losses can easily cross that line.
Reclassification also ripples across prior years when the IRS examines several at once, which is common because auditors look at the income and loss history across the full presumption window. Four consecutive years of Schedule C losses can be adjusted together. Combined taxes, interest, and penalties across those years often outweigh whatever the original deductions saved.
If your activity consistently loses money and the nine factors do not support a profit motive, reporting the income as hobby income avoids the fight entirely. You lose the expense deduction either way. You also avoid the penalties and the audit.