Hobby or Business? How to Avoid the Hobby Loss Rules and Keep Your Write-Offs Safe

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Mark J. Kohler August 11, 2025 • 4 min

Mark J. Kohler, CPA and attorney, has helped millions of Americans improve their finances through practical, trustworthy tax and wealth strategies. Mark's mission is simple: deliver credible, actionable financial advice and guidance you can always rely on.

Business Building

If you’re not turning a profit, it’s not a business—it’s a hobby. And hobbies don’t get tax breaks. Here’s exactly how to keep the IRS from slapping the “hobby” label on your side hustle so you can protect your write-offs in 2025.

Why Hobby vs. Business Matters (More Than Ever)

Since the 2018 Tax Cuts and Jobs Act (TCJA), hobby-related deductions are completely off the table. That means if you’re reporting income from a side hustle but the IRS classifies it as a hobby, you still owe taxes on the income—and you can’t even deduct the expenses. Not one. Not the website, the gear, the travel, or the late-night supply runs. All of it gets tossed.

That’s a brutal spot to be in. You’re doing the work, spending the money, and still getting hammered at tax time. And in 2025, the IRS is cracking down even harder, especially with its shiny new enforcement budget and AI-powered audit flagging system that’s laser-focused on side hustles, digital income, and “questionable” business losses.

Prove You’re In It to Win It

Here’s the bottom line: if you want your losses to count, you need to show you’re running your operation with a genuine profit motive.

There are two ways to avoid the hobby loss rule:

1. The 3-out-of-5 Rule: Show a net profit in at least three of the last five consecutive years. (Two out of seven if you’re in the horse business—yes, horse lovers still get a pass.)

2. Show You’re Acting Like a Real Business: Even if you’re not yet profitable, you can still beat the hobby label if the facts and circumstances prove you’re trying to make money.

Here’s What the IRS Actually Looks At

The IRS uses nine key factors to decide if your activity is a business or a hobby. No one factor is decisive, they’re looking at the big picture. Here’s what you need to have locked down:

1. You keep solid books, records, and separate accounts.

2. You know what you’re doing, or hire experts who do.

3. You put in real time and effort, not just “when it’s convenient.”

4. Your assets (equipment, inventory) are expected to gain value.

5. You’ve had success running other ventures.

6. You’ve made profits, even occasionally.

7. You’re not just in it for the perks or fun (think fishing trips, car shows).

8. Your losses aren’t magically covered by your day job.

9. You make changes to improve results when things aren’t working.

Notice a pattern? Documentation and behavior matter. If you’re treating it like a real business, that’s what you need to prove.

Tighter Scrutiny and Less Wiggle Room in 2025

The IRS isn’t waiting for big red flags. With bigger budgets, sharper data tools, and stricter audit playbooks, they’re targeting side gigs that don’t even pass the smell test. If you’re showing losses year after year on a Schedule C, working a full-time job while claiming huge “business” write-offs, mixing in travel or personal perks, or running things without legit records or structure—you’re exactly who they’re looking for.

The worst part? You don’t even have to be audited for the IRS to disallow your deductions. They can make the change automatically and send you the bill.

The Fix: Set It Up Right

If you want to write off expenses and report legitimate losses, you’ve got to do the work upfront. That means setting up an LLC or S Corp if it makes sense, opening a separate bank account and credit card, and tracking every dollar. No guessing. Build a business plan and revisit it quarterly. Set revenue goals and actually adjust when you fall short. Don’t wing it. Get a CPA or legal pro who’s been down this road. Even if you’re not profitable yet, this kind of structure gives you the credibility to defend your losses and protect your deductions. And, frankly, it’s just good business.

If You Want Deductions, Act Like a Business

The hobby loss rules aren’t new, but 2025 brings new consequences. The IRS is evolving. So tighten things up, legitimize your setup, and document everything. You can still do what you love, just make sure there’s a real business behind it.

If you’re not sure your side hustle would survive an audit, or you’re running things on duct tape and good intentions, you’re gambling with your deductions. Whether you need LLC or S-Corp formation, entity clean-up, or a full tax and legal plan, head to kkoslawyers.com to explore services and book a consultation to get your operation structured to survive an audit and keep your write-offs. It’s not just about avoiding the hobby label—it’s about turning what you love into a real, tax-advantaged business that builds wealth over time.

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Mark J. Kohler