In Gregory v. Commissioner (2023 WL 3699087, 11th Cir. May 30, 2023), the Eleventh Circuit affirmed the Tax Court’s decision that the taxpayer’s deduction of costs related to a hobby, which were allowable to the extent of gross income from the hobby, are nevertheless subject to disallowance under the Code’s then applicable 2 percent floor for miscellaneous itemized deductions.

In 2014 and 2015, the Gregorys earned gross receipts from chartering their yacht. Their chartering activity was not a trade or business, but a hobby. Deductions attributable to this hobby were subject to disallowance under the “hobby loss” rules. See Code § 183. Under an exception to those rules, deductions can be allowed to the extent of gross income from the hobby. See Code § 183(b). The Gregorys did not dispute that their chartering activity was a hobby; they merely asserted that they could claim deductions for costs attributable to the hobby to the extent of gross income from their hobby.

The Eleventh Circuit, in a majority opinion by Judge Andrew Brasher, held that the Gregorys could not rely entirely on Section 183(b) in claiming their chartering hobby costs as deductions. The court held that the Section 183(b) deductions were miscellaneous itemized deduction subject to Section 67(a). Because the Gregorys had a very high income, their expenses associated with the chartering activity fell below 2 percent of their adjusted gross income. Judge Charles Wilson concurred in the result, but wrote separately to explain that the statute’s plain language was an insufficient basis for the outcome, which required additional consideration of congressional intent.

For the tax years at issue, the Eleventh Circuit’s decision appears to condone a tax on the Gregorys’ gross receipts from their chartering hobby. (There is no question that chartering income falls within the income tax. See Code § 61.) In particular, the Gregorys could not recover a portion of their basis in the yacht through depreciation during their chartering activity. Presumably, when the Gregorys dispose of the yacht, they will be able to recover their capital investment when computing gain or loss on the disposition. If not, the overall tax result would be problematic.