By Ken Berry, JD.
For decades, the IRS and taxpayers often squared off in Tax Court to determine if expenses incurred in activities mixing business and pleasure—like horse racing and breeding—were deductible under the “hobby loss rules.” But now that deductions for hobby expenses are completely off the table, the stakes are even higher. In a new case, Schumacher TC Memo 2026-27, 6/9/26, the Tax Court put the taxpayers out to pasture.
Background: Previously, you could deduct expenses incurred in a hobby, like woodworking or needlepointing, up to the amount of income from the hobby. These deductions were claimed as miscellaneous itemized deductions subject to a floor of 2% of adjusted gross income (AGI). But you were not able to deduct losses in excess of your hobby income.
Conversely, if you engaged in the activity with the intent to turn a profit, you might deduct expenses as business expenses, even if you showed a loss. There is no 2%-of-AGI floor on business deductions.
However, the Tax Cuts and Jobs Act (TCJA) suspended the deduction for miscellaneous expenses from 2018 through 2025. And last year, the One Big Beautiful Bill Act (OBBBA) permanently eliminated those deductions. So now it’s truly all-or-nothing concerning hobby-like expenses.
Facts of the new case: A couple established a sole proprietorship in 2001 with the intention of breeding show horses. The husband is a veterinarian who owns a practice where he works over 60 hours a week while the wife is a full-time professional in the education field.
The couple devoted significant time to breeding and training their horses, even building a $230,000 indoor riding area on their property to facilitate year-round riding and training. But they continuously operated at a loss for about 20 years with each annual loss exceeding $100,000.
Although they maintained a separate account for the horse breeding activity, the taxpayers replenished this account from their personal checking account, effectively using their funds as overdraft protection. They frequently paid house-related expenses directly from their personal accounts.
During this entire time, the couple relied on an enrolled agent (EA) to prepare their tax returns. They provided him with notes rather than maintaining a formal ledger or utilizing business recordkeeping software. The EA advised them that they qualified for deductible losses even though they never turned a profit.
Based on the prevailing regulations, the Court answered the following questions to determine if the activity constitutes a business or a hobby:
- Does the taxpayer have a businesslike manner while carrying on the activity?
- Is the taxpayer an expert or an advisor?
- Does the taxpayer devote the necessary time and effort?
- Does the activity create an appreciable asset?
- Are there successes in similar activities?
- What is the history of activity income or loss?
- Have there been occasional profits?
- Is there a stable financial status?
- Is the activity undertaken for personal pleasure or recreation?
After examining all the evidence, the Tax Court ruled that the activity doesn’t rise to the level of a business.
Result: All the loss deductions are denied.
Tax presumption: If you show a profit in any three out of the last five consecutive years, the IRS will presume that the activity isn’t a hobby. Even better, a profit is required for only two out of seven years for an activity involving the breeding, training, showing or racing of horses. If your clients aren’t taking advantage of this presumption, they should get on their horse!
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Tags: business, business deductions, business losses, hobby, Income Taxes, IRS, Taxes
