How To Reduce Tax Liability With A Hobby

Did you know that you can learn how to reduce tax liability with a hobby? Yes, that's correct. The key though is that your hobby must be, per IRS rules, for-profit.

Per IRS ruling, a for-profit hobby is defined as "An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses)."

So, if you can make money from that certain passion in your life, such as creating pottery, painting or even car racing, you can reduce tax liability with your hobby by following just a few tax deduction strategies.

1. Reduce your Adjusted Gross Income (AGI). Your AGI is the total amount that you pay taxes on yearly. If you have a hobby which creates income, such as selling pottery, all of the equipment or associated expenses to make your hobby item is fully deductible, although you must claim the sales as part of your AGI. So, go out and buy a new pottery wheel, load up on glazes and other pottery supplies before April 15 and lower your AGI.
2. Keep a spreadsheet of all hobby related expenses throughout the year. Tracking your expenses is key to making sure that you claim all of the deductions available. And, don't think that the $2 glaze you purchased doesn't count; it does. Small expenses add up to large expenses.
3. Keep a record of your car mileage when used for your hobby. If you're delivering a pottery piece to a client, you can pay yourself fifty cents a mile (as of June 21, 2010) for each mile your car is used for your hobby. This payback money, ostensibly, will pay for wear and tear on your car. Don't try to deduct the cost of oil changes, though, as they're included in that fifty cents a mile.
4. Add up all of your expenses and record it on Schedule A, IRS Form 1040. A good idea is to be conservative in your deductions as this could possibly raise a red flag on your taxes if you're too aggressive in your claims.

Tips:

It's always good advice to check with a Certified Public Accountant before reducing tax liability with a hobby. The right person should be able to guide you on how to fly under the IRS radar.