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Hobby Loss Rules 2026: Hobby vs Business

There is no 90% hobby deduction limit in 2026. Hobby expenses are zero percent deductible. See the IRS nine-factor test and the 3-of-5-year profit rule.

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Quick Answer: Hobby Loss Rules for 2026

If you have read that 2026 brings a 90% cap on hobby expense deductions, that claim is wrong. The 90% figure comes from the One Big Beautiful Bill Act’s rewrite of the gambling loss rule and has nothing to do with hobbies. For hobbies, the 2026 answer is harsher: ordinary hobby expenses are not deductible at all, and that ban is now permanent.

Hobby income is still reported in full. That makes the hobby-versus-business classification worth real money, and it is settled by the nine-factor test in Treas. Reg. §1.183-2(b), not by how serious you feel about the activity.

Key Takeaways

  • No 90% hobby rule exists. OBBBA §70114 amended IRC §165(d), which covers losses from wagering transactions only. Section 183 (hobbies) is not referenced in it.
  • Ordinary hobby expenses are 0% deductible. OBBBA §70110 made the miscellaneous itemized deduction disallowance permanent, now codified at IRC §67(h).
  • The citation moved. The suspension used to sit at §67(g). OBBBA added a new §67(g) for educator expenses and redesignated the old subsection as §67(h). Pages still saying “§67(g)” are quoting the wrong provision.
  • Two things survive. Deductions allowed regardless of profit motive under §183(b)(1), and cost of goods sold, which Reg. §1.183-1(e) treats as an offset to gross receipts rather than a deduction.
  • Business status costs SE tax. Self-employment tax starts at $400 of net self-employment earnings, at 15.3% on 92.35% of net income.
  • 3 of 5 years is a presumption, not a rule. IRC §183(d) presumes profit motive after profits in 3 of 5 consecutive years, or 2 of 7 for horse activities.

The 90% Hobby Deduction Rule Does Not Exist

Several sites ranking for “hobby loss rules 2026” state some version of this: taxpayers can now deduct hobby expenses only up to 90% of hobby income, so 10% of hobby income is always taxable.

It is a misread of a real change. The One Big Beautiful Bill Act (P.L. 119-21), at §70114, amended IRC §165(d), the provision governing “losses from wagering transactions.” The amended text allows a deduction equal to 90 percent of wagering losses, and only to the extent of gains from those transactions, for tax years beginning after December 31, 2025.

Section 165(d) is limited by its own terms to wagering. Hobbies live under IRC §183, which §165(d) does not mention and which §70114 did not touch. There is no cross-reference in either direction. If you want the 90% rule explained where it actually applies, read our breakdown of the 90% gambling loss deduction limit for 2026.

Notice which direction the error runs: the myth promises a 90% write-off where the real rule gives you zero. A reader who trusts it will overstate deductions and understate tax, then find out during an examination.

How 2026 Actually Taxes a Hobby

Hobby income is gross income. You report it on Schedule 1 (Form 1040), line 8j, labeled “Activity not engaged in for profit income,” and it carries to line 8 of the Form 1040. There is no Schedule C, and no self-employment tax.

The expense side is where 2026 differs from what most people remember. Before 2018, hobby expenses were deductible up to the amount of hobby income, as miscellaneous itemized deductions subject to the 2% floor. The Tax Cuts and Jobs Act suspended that whole category through 2025, and hobby expenses went with it.

That suspension was scheduled to lapse on January 1, 2026. It did not. OBBBA §70110 struck the sunset language, making the disallowance permanent for tax years beginning after December 31, 2025. The provision now reads at IRC §67(h), because §70110(b)(2) added a new §67(g) covering educator expenses and redesignated the former suspension subsection as (h).

So for supplies, entry fees, software, travel, marketing, and equipment tied to a hobby, the deduction is gone and is not coming back on a schedule.

The two carve-outs

Section 183(b)(1) deductions. Deductions that are allowable “without regard to whether or not such activity is engaged in for profit” still work. Mortgage interest and state and local taxes are the usual examples. They stand on their own footing under Schedule A rather than counting as hobby deductions, so they only help if you itemize instead of taking the standard deduction.

Cost of goods sold. This one is missed almost everywhere and it matters most to the biggest slice of hobby taxpayers: people who sell things. Treas. Reg. §1.183-1(e) provides that a taxpayer may determine gross income from an activity by subtracting cost of goods sold from gross receipts, so long as it is done consistently and in accordance with generally accepted accounting principles.

COGS is an offset in arriving at gross income, not a deduction from it. A crafter with $500 of sales and $300 of materials in those goods reports $200 of hobby income, not $500.

Worked example: $6,000 of craft sales

Say you sell handmade goods online. For the year: $6,000 in sales, $3,000 in materials that went into the items sold, and $1,500 in booth fees, listing fees, shipping supplies not billed to buyers, and advertising. Assume a 22% marginal rate.

Hobby vs. business treatment of the same $6,000 activity in 2026
ItemHobbyBusiness (Schedule C)
Gross receipts$6,000$6,000
Cost of goods sold-$3,000-$3,000
Other operating expenses$0 (disallowed)-$1,500
Amount reaching the return$3,000 (Schedule 1, line 8j)$1,500 net profit
Self-employment tax$0$212
Income tax at 22%$660$245
Total federal tax$660$457

The business column works like this: net profit of $1,500, net self-employment earnings of 92.35% x $1,500 = $1,385.25, SE tax of 15.3% x $1,385.25 = $211.94. Half of that ($106) is deductible above the line. A 20% QBI deduction on $1,394 of qualified business income is another $279, leaving $1,115 subject to income tax, or $245 at 22%.

Same activity, same cash, roughly $200 less federal tax as a business. The gap widens fast when the activity has real overhead, because the hobby column deducts none of it. It flips the other way when the activity has almost no deductible costs, where self-employment tax outweighs what the deductions and QBI save.

If you want to see the number for your own situation instead of a stylized one, Tax47 lets you drop the activity in as a Schedule C alongside your W-2 and watch self-employment tax, QBI, and the refund recompute as you type. Our self-employment tax calculator handles the SE piece on its own.

The IRS Nine-Factor Test

Whether an activity is “engaged in for profit” is a facts-and-circumstances question. Treas. Reg. §1.183-2(b) lists nine factors that the IRS and the courts weigh. No single factor controls, and the list is not exhaustive. A taxpayer can lose on a majority of factors and still win, and the reverse happens too.

  1. Manner in which the taxpayer carries on the activity. Separate bank account, real bookkeeping, a written plan, and changes in method after bad years. This is the factor you have the most control over.
  2. The expertise of the taxpayer or his advisors. Study of the business practices of the field, not just the craft itself. Consulting people who know the economics counts.
  3. The time and effort expended by the taxpayer in carrying on the activity. Substantial hours, especially hours devoted to unglamorous parts of the work, point toward profit motive.
  4. Expectation that assets used in the activity may appreciate in value. An overall profit can come from appreciation of land or equipment even if operations lose money.
  5. The success of the taxpayer in carrying on other similar or dissimilar activities. A history of turning other ventures, similar or not, from unprofitable to profitable helps you.
  6. The taxpayer’s history of income or losses with respect to the activity. Early losses in a startup phase are expected. A long unbroken run of losses past that stage is the classic red flag.
  7. The amount of occasional profits, if any, which are earned. Small profits against large losses and a large investment suggest no profit motive. An occasional large profit against small losses suggests one.
  8. The financial status of the taxpayer. Substantial income from other sources, particularly when the losses generate tax benefits, weighs against you.
  9. Elements of personal pleasure or recreation. Enjoyment does not disqualify an activity, though recreational appeal paired with persistent losses is exactly what the IRS looks for.

Factor 6 combined with factor 8 is the pattern that draws attention: sustained losses on an enjoyable activity, claimed by someone with enough wage income to absorb them. That combination also shows up on our list of 2026 IRS audit triggers.

The 3-of-5-Year Profit Presumption and Form 5213

IRC §183(d) gives taxpayers a safe harbor. If an activity produced gross income exceeding deductions in 3 or more of the 5 consecutive tax years ending with the current year, the activity is presumed to be engaged in for profit unless the IRS establishes otherwise.

For activities consisting mainly of breeding, training, showing, or racing horses, the test is 2 of 7 years.

Two things people get wrong about this presumption:

  • It is rebuttable. Meeting 3 of 5 shifts the burden to the IRS. It does not end the inquiry.
  • Missing it proves nothing. Plenty of legitimate businesses lose money for five straight years. Failing the presumption simply means you carry the burden of showing profit motive under the nine factors.

Form 5213: read the fine print

Form 5213 lets you elect to postpone the determination of whether the presumption applies until the end of the 5-year window, or 7 years for horse activities. It sounds like breathing room, and for a genuine startup it can be.

The cost is real. The election extends the statute of limitations for assessing tax attributable to that activity for every year in the presumption window. You are giving up a shorter audit window in exchange for that time. Most practitioners treat it as a last resort rather than routine planning, and it is worth a conversation with a professional before filing it.

What Changes If It Is a Business

Business classification opens the deduction side and hands you a tax bill at the same time.

What you gain:

  • Ordinary and necessary expenses under §162, deducted on Schedule C: supplies, software, fees, mileage, insurance, professional services.
  • Losses that offset other income. A Schedule C loss can reduce wage income, subject to the passive activity and at-risk limits. A hobby can never produce a deductible loss.
  • The QBI deduction of up to 20% of qualified business income.
  • The home office deduction, if you have a space used regularly and exclusively for the business.

What it costs:

  • Self-employment tax. It applies once net self-employment earnings reach $400, at a combined 15.3% (12.4% Social Security plus 2.9% Medicare) on 92.35% of net earnings. The Social Security portion stops at the 2026 wage base of $184,500. Details in our guide to how the 15.3% works.
  • Quarterly estimated payments. Nobody withholds on Schedule C income, so the shortfall becomes a penalty unless you pay estimates during the year.
  • More recordkeeping. Mileage logs, receipts, a defensible expense allocation between business and personal use.

The $400 line is the sharpest edge in the whole comparison. Below it, no SE tax either way. Above it, misclassifying a business as a hobby means unreported SE tax, and misclassifying a hobby as a business means deductions you cannot defend.

You do not get to pick whichever label you prefer. If you receive a Form 1099-K from a marketplace or a Form 1099-NEC from a client, the IRS already has a copy, and the only question is which line of your return the money lands on.

Build the Profit-Motive Record Before Anyone Asks

Factor 1 of the nine, the businesslike manner factor, is the one you can still change today. Turn the regulation into a checklist:

  • Open a separate bank account for the activity and stop running personal purchases through it.
  • Keep actual books. Accounting software, a consistent chart of accounts, monthly reconciliation. Not a shoebox and not a spreadsheet you rebuild each April.
  • Write a plan. A few pages with your market, your pricing, your cost structure, and a path to profit. Date it.
  • Document what you changed after a loss year. Raised prices, dropped an unprofitable product line, switched suppliers, cut ad spend. Courts weigh this heavily, and it is the evidence people never keep.
  • Show market research. Competitor pricing, demand data, whatever informed your decisions.
  • Consult advisors and keep the record. Emails and invoices from a CPA, an attorney, or an industry consultant support factor 2.
  • Track your hours. A simple time log makes factor 3 concrete instead of a recollection years later.
  • Keep marketing evidence. Listings, ads, a website, outreach to customers. Real selling effort separates a business from a pastime.

This record costs almost nothing to maintain while the activity is running and is close to impossible to reconstruct once an examination letter arrives.

Sources & References

This article is for educational purposes only and provides estimates, not tax, legal, or financial advice. Tax rules change periodically, always check current IRS guidance or consult a qualified tax professional.

Frequently Asked Questions

Can I deduct hobby expenses in 2026?

No. OBBBA Section 70110 permanently disallowed miscellaneous itemized deductions (IRC Section 67(h)), and ordinary hobby expenses fell in that category. You report hobby income in full and deduct nothing for supplies, fees, or equipment. Deductions like mortgage interest and state and local taxes still work on their own footing under Section 183(b)(1), and a hobby seller may subtract cost of goods sold from gross receipts.

Is there a 90% limit on hobby loss deductions for 2026?

No. The 90% limit comes from OBBBA Section 70114, which amended IRC Section 165(d) and applies only to gambling losses. It has nothing to do with hobbies. Pages claiming a 90% hobby deduction are describing a rule that is more generous than the law. For hobbies the correct figure is zero.

How many years can a business lose money before the IRS calls it a hobby?

There is no hard limit. IRC Section 183(d) creates a presumption that an activity is for profit if it turned a profit in at least 3 of the last 5 consecutive years, or 2 of 7 for horse breeding, training, showing, or racing. Missing that does not make you a hobby. It means you carry the burden of proving profit motive under the nine-factor test.

What are the nine factors the IRS uses to decide hobby vs business?

Treas. Reg. Section 1.183-2(b) lists them: how businesslike you run the activity, your or your advisors' expertise, time and effort spent, expected appreciation of assets, success in other ventures, the activity's income and loss history, the size of occasional profits, your financial status, and elements of personal pleasure or recreation. No single factor decides it.

Where do I report hobby income on my tax return?

On Schedule 1 (Form 1040), line 8j, Activity not engaged in for profit income, which flows to line 8 of Form 1040. Hobby income does not go on Schedule C, and it is not subject to self-employment tax.

Do I pay self-employment tax on hobby income?

No. Self-employment tax applies to a trade or business and kicks in at $400 of net self-employment earnings, at 15.3% on 92.35% of net income. Hobby income is not self-employment income, so there is no SE tax. That is the one way the hobby classification helps you.

What is Form 5213 and should I file it?

Form 5213 postpones the IRS determination of whether the profit presumption applies until the end of the 5-year window, or 7 years for horse activities. The catch is that filing it extends the statute of limitations for the IRS to assess tax on that activity for every year in the window. Most practitioners treat it as a last resort.

What if the IRS reclassifies my business as a hobby?

You lose every ordinary expense deduction for the years at issue, the losses you used against wages or other income are added back, and you may owe back tax plus interest and accuracy-related penalties. The defense is contemporaneous evidence of profit motive: separate accounts, real books, a written plan, and documented changes made after loss years.