Beat the OBBBA/TCJA Rules That Punish Dog Breeding Hobbies
- Viktoriya Barsukova, EA, MBA
- Oct 6
- 5 min read
The One Big Beautiful Bill Act (OBBBA) permanently extends a harsh provision from the Tax Cuts and Jobs Act (TCJA): the ban on deducting “more than 2 percent” miscellaneous itemized deductions.¹
For dog breeders, this rule is especially painful. The IRS often views breeding as a hobby rather than a business, and hobbies are a tax disaster.
Expenses tied to a hobby aren’t deductible,² but income is still fully taxable. In fact, hobby income must be reported separately on Schedule 1 (Form 1040), line 8j—making the imbalance even more obvious.³
There is one small break: hobbyists who sell inventory, such as puppies, can reduce their taxable hobby income by the direct costs of raising and preparing those animals for sale.⁴ But beyond this narrow exception, the tax rules leave hobby breeders exposed.
The good news? You don’t have to accept hobby status. By structuring your dog breeding as a business, you can unlock significant tax benefits and escape the OBBBA/TCJA trap.
The Business Escape
Make your dog breeding activity a business. As a business, it escapes all the trouble above and can generate generous tax benefits.
For tax purposes, a “business” is any activity which you engage in regularly and continuously primarily to earn a profit.⁵ Your desire to earn a profit doesn’t necessarily have to be reasonable in the eyes of the world. But you must have an actual, honest, and bona fide objective of making a profit.⁶
Your dog breeding activity doesn’t have to show a profit every year (or most years) to qualify as a business. As long as your primary purpose for dog breeding is to make money, it will qualify as a business (even if you show a loss some years).
It can be a full-time or part-time dog breeding business, as long as you work at it regularly and continuously. And you can have more than one business at the same time.
But if your primary purpose for dog breeding is something other than making a profit—for example, to reap the enjoyment and fulfillment that comes from breeding dogs—your activity is a tax-disadvantaged hobby rather than a business.
The Two IRS Tests
The IRS has established two tests to determine whether someone is in business. If you can pass either one, your dog breeding activity is a business.
Test 1: The three-of-five-years safe harbor.
Test 2: The facts and circumstances test.
Test 1: The Three-of-Five-Years Safe Harbor
If your dog breeding activity earns a profit in three of any five consecutive years, the IRS must presume that you have a profit motive and you’re in business.⁷
The IRS can still claim that dog breeding is a hobby, but it will have to rebut the presumption that you have a profit motive—for example, by showing that your profits were small and your losses large. In practice, the IRS usually doesn’t attack ventures that pass the profit test.
The presumption that you are in business applies only to your third profitable year. It then extends to all subsequent years within the five-year period beginning with your first profitable year.⁸ Therefore, losses you incur in the first several years will never be protected under the safe harbor rule, whether or not dog breeding turns a profit in later years.
Example:
Bill began dog breeding in 2021. His income from the activity varied dramatically from year to year.
If the IRS audits Bill’s taxes for 2025, it must presume that he was in business during that year because he earned a profit during three of the five consecutive years ending with 2025. The presumption that Tom is in business extends through 2026, the final year in the five-year period starting with his first profitable year (2022).
But the presumption does not apply to years 2021 through 2024. Thus, the IRS can assert that the losses incurred in 2023 are non-deductible hobby losses. Tom must rely on the behavior test for those years.
Taxpayers may elect to delay an IRS determination as to whether the safe harbor applies until the close of the fourth tax year after the tax year they first began the activity.⁹
If the election is made and the activity is profitable for three or more of the five years, the IRS will presume you engaged in the activity for profit throughout the entire five-year period. You make this election by filing IRS Form 5213, Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit, and executing a waiver of the statute of limitations.¹⁰
Key point: Taxpayers rarely file Form 5213 because it alerts the IRS that their activity might be a hobby.
Test 2: The Facts and Circumstances Test
Many dog breeders can’t show a profit for three out of five years. If you’re one of them, however, by no means do you have to throw in the towel and accept hobby status.
Breeders with many years of losses have been able to establish that their activity is a business by passing the facts and circumstances test. Unlike the three-of-five-years test, this test is highly subjective.
The IRS looks at the relevant facts and circumstances to determine whether you have a profit motive for your dog breeding activity. The IRS looks at nine main factors:¹¹
Manner of operation: Do you operate in a businesslike manner? (This is the most important factor.)
Expertise: Do you (or your advisors) have knowledge and expertise in dog breeding?
Time and effort: Do you devote substantial time and effort to the activity?
Expectation of asset appreciation: Are your breeding dogs or assets expected to appreciate in value?
Success in similar activities: Have you succeeded in other similar ventures?
History of income and losses: Are there profits in some years, or only recurring losses?
Amount of occasional profits: Are profits substantial relative to your investment?
Financial status: Is this your main source of income?
Elements of personal pleasure: Is the activity primarily recreational?
You don’t have to satisfy all of these factors (or even a majority) to pass the test. The first three—acting like a business, expertise, and time and effort—carry the most weight.
Real Case Example
One Hawaii couple breeding championship poodles proved their activity was a business despite five years of losses. They succeeded because they:
Maintained records and separate accounts.
Advertised widely and showed dogs nationally.
Worked full time in the business.
Increased the value of their breeding stock through national titles.
Their case established a strong precedent for dog breeders.¹²
Ways to Help Establish a Profit Motive
Operate in a businesslike manner. Act like you want to earn a profit.
Keep good business and inventory records.
Maintain a separate checking account for the activity.
Obtain necessary licenses and permits.
Market your breeding business professionally (website, social media, expos, referrals).
Combine breeding with a kennel or grooming business.
Create a written business plan and financial forecast.
Consider forming a business entity such as an LLC or C corporation.
Track and document the time you spend working in the business.
Takeaways Beat the OBBBA/TCJA Rules That Punish Dog Breeding Hobbies
The OBBBA cements the TCJA’s prohibition on deducting hobby expenses, making dog breeding especially risky if treated as a hobby.
While hobby income is always taxable, hobby expenses (other than cost of sales) are not deductible—leaving breeders exposed to unfavorable tax results.
The only real protection lies in demonstrating a genuine profit motive.
By keeping detailed records, marketing effectively, creating a business plan, and treating dog breeding like a true enterprise, breeders can avoid hobby classification and unlock valuable tax benefits.
Beat the OBBBA/TCJA Rules That Punish Dog Breeding Hobbies
By - W. Murray Bradford, CPA
Publisher Tax Reduction Letter
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