The One Big Beautiful Bill Act (OBBBA) permanently extended a harsh TCJA rule: no deduction for “miscellaneous itemized deductions,” including hobby expenses. That’s brutal for dog breeders, because the IRS often labels breeding as a hobby. Translation: income gets taxed, expenses don’t. Hobby income is reported separately on Schedule 1, but most related costs are simply nondeductible.
There is a narrow carve-out: if you sell inventory (puppies), you can reduce taxable hobby income by direct costs tied to those sales. Beyond that, hobby treatment is a tax dead end.
Good news: you don’t have to accept hobby status. If you structure and run breeding as a business, you unlock deductions and escape the OBBBA/TCJA penalty box.
What Counts as a “Business” (for Tax Purposes)
A business is an activity you pursue regularly and continuously with a primary objective of making a profit. You don’t need to show profits every year, and it can be part-time, but the intent to earn has to be real and supported by your behavior.
The IRS uses two paths to decide:
Test 1: Three-of-Five-Years Safe Harbor
If you post a profit in three of any five consecutive years, the IRS presumes you’re in it for profit. They can try to rebut it, but in practice they usually don’t attack ventures that meet this safe harbor.
- The presumption applies beginning with your third profitable year and runs through the five-year window that starts with your first profitable year.
- Loss years before that third profit aren’t protected by this safe harbor, so you still need to behave like a business early on.
Example (simplified):
A breeder begins in 2021. Results: 2021 loss, 2022 profit, 2023 loss, 2024 profit, 2025 profit. Because there are profits in three of five by 2025, the IRS must presume a profit motive in 2025 (and through the end of the 5-year window beginning in 2022). Earlier loss years still rely on the behavior test below.
There’s an election (Form 5213) to postpone an IRS determination until enough years have passed to measure the safe harbor. It’s rarely used, because it invites attention.
Test 2: Facts-and-Circumstances (Behavior)
Can’t show three-of-five yet? You can still win by acting like a business. The IRS weighs nine factors; you don’t need all nine, but the first three carry the most weight:
- Manner of operation: separate bank account, accurate books, invoices, contracts, budgets, cost tracking, advertising.
- Expertise: training, advisors, industry reading, shows/seminars, pedigrees, genetics knowledge.
- Time and effort: regular, sustained work; a calendar that proves it.
- Expectation of asset appreciation: breeding stock, bloodlines, and titles that increase value.
- Success in similar ventures: prior wins running other businesses help.
- History of income/losses: losses are tolerable early; persistent large losses are not.
- Magnitude of profits when they occur: real dollars, not token gains.
- Financial status: if this activity matters to your livelihood, it looks more businesslike.
- Personal pleasure: enjoying the work isn’t fatal, but if pleasure dominates, the IRS calls it a hobby.
Courts have allowed business treatment where breeders integrated operations (for example, breeding plus grooming and kennel services), kept rigorous records, marketed actively, invested in handlers, and built championship lines that appreciated.
How to Tilt the Facts in Your Favor (Action List)
- Operate like a business.
- Separate checking account and payment methods.
- Full books: income/expense detail, COGS, litter-by-litter profitability.
- Written policies: health, returns, deposits, stud agreements, waitlists.
- Licenses, permits, insurance.
- Document the dogs like inventory.
- Breeding records, veterinary logs, pedigrees, titles, whelping schedules, mortality and cull tracking.
- Maintain COGS detail so you can show unit economics.
- Market like you mean it.
- Website with pricing and policies, show schedule, social channels, lead list, email follow-ups.
- Ads in breed publications; collaborate with vets, trainers, and clubs.
- Write a plan and update it annually.
- 3–5 year P&L/COGS forecast, capital plan (kennels, equipment), pricing, and cash needs.
- Show the path to profit even if it’s not year one.
- Consider integration.
- Pair breeding with grooming and/or boarding to build recurring revenue and demonstrate commercial intent.
- Choose an entity thoughtfully.
- An LLC taxed as sole prop or S corp is typical for liability and admin simplicity.
- A C corporation isn’t subject to hobby-loss rules, but losses are trapped at the corp level and don’t pass through.
- Track your time.
- Calendar entries beat memories. Weekly hours across marketing, whelping, training, sales.
Quick Diagnostics: Are You Signaling “Business” or “Hobby”?
| Signal | Businesslike | Hobbylike |
|
Banking & books |
Separate account, monthly close, COGS detail |
Mixed funds, shoebox receipts |
|
Sales & marketing |
Website, ads, shows, contracts |
Word-of-mouth only |
|
Records |
Vet logs, breeding plans, titles, unit margins |
Minimal documentation |
|
Time |
Regular weekly hours |
Sporadic bursts |
|
Profit plan |
Written plan with pricing and targets |
“See what happens” |
|
Complementary ops |
Grooming/boarding add-ons |
None |
Takeaways
- Hobby treatment is a tax trap. Income is taxable; most expenses are not.
- You can escape by qualifying as a business through either:
- the three-of-five safe harbor, or
- the behavior test that proves profit motive.
- Winning facts: businesslike operations, credible expertise, regular effort, measurable COGS and margins, real marketing, and a plan that shows when profits appear.
- Entity choice and integrated services can strengthen the case and improve economics.
Bottom line: If breeding is truly about profit, make your paperwork and operations prove it. Do that, and you neutralize the OBBBA/TCJA hobby penalty and get the deductions a real business deserves.
This post is general information, not tax or legal advice. Implementation depends on your facts. We help breeders set up books, policies, pricing, and documentation that stand up in an audit.