There is a “hobby loss” rule that limits deductions attributable to an activity not engaged in for profit. If the activity is not engaged in for profit, the taxpayer may deduct, in the following order (Sec. 183)

Example:
Helen creates beautiful ceramics as an outlet for her personal creativity. This year, friends and family started asking her if they could buy them from her. She didn’t really want to create a business or make a profit but she does have expenses. She sold $2,000 worth of ceramics in 2008. Her expenses were $3,500 but only $2,000 is deductible (subject to the 2% of adjusted gross income limitation) because that is the amount of income she earned. 

Warning: The IRS has noted taht claiming losses from hobby activities in excess of income is one of the ost common errors made on individual income tax returns. 

If the activity is a “hobby,” then income is reported on page 1 of Form 1040 as “other income” and expenses are reported as miscellaneous itemized deductions on Schedule A (subject to the 2%-of-AGI limit). 

If Helen wants to deduct the entire $3,500 of expenses even though she only has $2,000 of income this year, she will need to have profit in 3 out of 5 consecutive years. 

Please check with your tax preparer as your situation may be different than described.