The first rule of income taxation is that personal expenses cannot be deducted from income. Section 162 of the Internal Revenue Code (the "Code") authorizes the deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." It's pretty broad. However, Section 183 of the Code limits deductions for activities that are "not engaged in for profit." Section 183 is designed specifically to prevent recharacterization of non-deductible personal and hobby expenses as deductible business expenses. The main issue that has evolved from these Code sections is whether the taxpayer has a "profit motive."
Reg 1.183-2(b) lists nine nonexclusive factors by which the Internal Revenue Service (the "Service") will measure the taxpayer's motive:
(1) Does the taxpayer carry on the activity in a business-like fashion?
(2) What is the level of the taxpayer's expertise with the activity, and does the taxpayer attempt to become more experienced and knowledgeable in the activity?
(3) How much time and effort does the taxpayer expend in carrying on the activity?
(4) Is there an expectation that assets used in the activity may appreciate in value?
(5) How successful has the taxpayer been in carrying on other similar or dissimilar activities?
(6) What is the taxpayer's profit/loss history?
(7) How much profit is earned?
(8) What is the financial status of the taxpayer, e.g. does s/he have other sources of income?
(9) What is the degree to which the activity is primarily related to personal pleasure or recreation?
So the first question is whether you are doing something to make money, or whether you're just messing around. Section 183(d) of the Code contains a presumption of profit motive if an activity shows a profit in three out of five years. Therefore, if you show a profit from the activity for three of five years, you will probably not face any challenges from the Service concerning whether your "business" is really a hobby.
Even if you do have a profit motive, there are limits to which you can offset business losses against ordinary income. Ordinary income for individuals is their salary, wages, self employment income and active business income. If you are engaged in what is called a "passive activity," you can only offset passive activity losses against passive activity gains.
The passive loss rules were designed to wipe out tax shelters. Those tax shelters related primarily to property leasing. Under the most common tax shelters, a bunch of doctors and dentists (for some reason, the participants in the tax shelters always seemed to be doctors and dentists) would form or buy into a limited partnership that leased real property to third parties. Leasing real property is a great way to generate paper losses because you can depreciate structures and do some other neat things to mess around with the bottom line without costing you real money. So at the end of the year, the limited partners would receive a "phantom loss" from the limited partnership that they could use to reduce income from their regular business activities.
Congress enacted what became section 469 of the Code to deal with that problem. Now, you have to show that you engage in business activity (1) regularly, (2) continuously and (3) substantially in order to avoid application of the passive loss rules. So if your divemaster activities are not "active" even though you show "profit motive," you will not be allowed to offset losses from the divemastering business against ordinary income--like your salary.
Likewise, business travel expenses are subject to various limits, specifically to prevent recharacterization of personal vacations as business trips.
Assuming your divemastering qualifies as an "active" business activity, you might not be able to deduct the full amount of your equipment purchases in a single year. Reg. 1.461-1(a)(1) generally requires that when a cash method taxpayer makes a payment to acquire an asset that has a useful life substantially beyond the current taxable year, the taxpayer is required to treat that payment as a capital expenditure. However, under section 179 of the Code, you can elect to "expense" up to $24,000.00 of capital assets under certain circumstances. Generally, small businesses without many capital assets can qualify for the section 179 election.
This area is fairly complicated, and it can't be addressed in a brief post (as the foregoing should demonstrate). There are all sorts of misunderstandings about business deductions generally, and you can get yourself into trouble by relying upon someone who isn't a tax professional. Spend an hour with your accountant or a tax attorney if you're serious about trying to deduct scuba-related expenses as business-related expenses. It's money well-spent.
