Limitations on Certain Business Deductions

Question 1

When can hobby expenses be deducted?

Answer 1

-If hobby generates revenue

Question 2

Can hobby losses be deducted?

Answer 2

-No

Question 3

How can taxpayers avoid the hobby designation?

Answer 3

• By proving there is a real profit motive in conducting the activity
• If 3/5 yrs there’s a profit, IRS has burden of proof
• If 3/5 yrs there’s a loss, taxpayer has burden of proof

Question 4

What are the provisions associated with hobby deductions?

Answer 4

• Can only be deducted as 2% misc items
• Expenses not allowed due to insufficient income do not carry over to future years
• Expenses deducted in following order
  1) Interest and taxes (fully deductible as itemized deductions)
  2) Cash expenses
  3) Depreciation

Question 5

Are home office expenses deductible? With what conditions?

Answer 5

• Yes for portion of residence used as an office
• If taxpayer an employee, office must be used for convenience of employer
• Expenses must be allocated between portion of dwelling used as residence and the office
• Office deductions applied in same order as hobby deductions
• Excess deductions carryforward and can be used when business income is sufficient

Question 6

Explain the vacation home expense deduction.

Answer 6

• If rented for less than 15 days a year, treated as a personal residence
• If rented 15 days or more, and not used for personal purposes the greater of 14 days or 10% of days rented, treated as rental property and rental loss is allowable
• If rented 15 days or more, and it is used for personal purposes the greater of 14 days or 10% of days rented, treated as personal/rental property. All regular expenses prorated and rental loss not allowed. Same order as hobby deductions

Question 7

Who do passive loss limitations apply to?

Answer 7

• Individuals
• Estates
• Trusts
• Personal Service Corporations
• Closely held C Corporations

Question 8

What is an exception to the limitations on passive losses?

Answer 8

• For taxpayers who actively manage rental realty (own at least 10% of property and significantly participate in decision making)
• Active manager can deduct a maximum loss of $25,000 per year phased out at 50% for AGI over $100,000

Question 9

Explain the suspended loss rule for passive losses.

Answer 9

-Suspended losses become deductible in later years if income generated or activity is sold