FS-2007-23, September 2007

Many people don’t realize the income they earn from auctions and
consignment sales may be taxable. This fact sheet, the 16th in the Tax
Gap series, will help taxpayers better understand what income they are
required to report and what deductions they may be entitled to take.

The tax gap,
or the amount of tax that goes unpaid each year, results from taxpayers
underreporting their taxable income. Fortunately most people want to
pay their fair share of taxes and many simply need a better
understanding of their obligations.

What’s Taxable

All income from auctions, traditional or online, and consignment
sales is generally taxable unless certain exceptions are met. This
income is usually considered either “business” or “ordinary” income. In
certain circumstances such income can qualify for capital gain
treatment. There are also some exceptions where income can be excluded
from taxable income.

Business income resulting from an auction or consignment sale is
subject to the same taxes as the income of any other retail or service
business. That may include income tax, self-employment tax, employment
tax, or excise tax. A retail or service business owner must include
this income in his or her business income.

A person must report a gain from a sale whether he or she operates a
business or not. A reportable gain is the income above the original
cost or basis of the item. These gains may be business income or
capital gains.

Income resulting from auctions akin to an occasional garage or yard
sale is generally not required to be reported. However, there may be
exceptions. If an online garage sale turns into a business with
recurring sales and purchasing of items for resale, it may be
considered an online auction business.

Some people sell a product or service online as a hobby. This income
generally must be reported and deductible expenses are limited. The
deductions cannot total more than the income reported and can only be
taken if deductions are itemized on Form 1040, Schedule A, Itemized
Deductions.

For additional information about whether an activity is a business
or a hobby, see April’s fact sheet titled, Business or Hobby? Answer
Has Implications for Deductions.

What’s a Deductible Expense

Traditional or online auction and consignment sellers in the
business to make a profit can generally deduct expenses that are both
ordinary and necessary. An “ordinary” expense is one that is common and
accepted in a trade or business. A “necessary” expense is one that is
helpful and appropriate for a trade or business. Verifiable auction and
consignment fees and commissions are examples of allowable business
expenses.

Expenses related to personal, living, or family matters are
generally not deductible. There are expenses that are partly personal
and partly business-related. The business portion of the expense is
deductible.

Here’s a simple example. A person might borrow $10,000, using $7,000
for personal use and the other $3,000 for his or her online auction
business. The interest expense on the $7,000 is not deductible but the
interest on the other $3,000 is deductible. Chapter 5 of Publication 535, Business Expenses, can help a taxpayer understand these rules better.

A common split expense issue is a person’s home that they also use
for their business. That person may be able to deduct expenses for the
business use of the home if they meet the regular use requirement and
the exclusive use requirement.

However, auction and consignment sellers may compute their deduction
to the extent of expenses allocable to space in the residence that is
used on a regular basis (does not have to be exclusive) to store
inventory and/or product samples if the residence is the sole fixed
location of the retail or wholesale auction or consignment business.
Allocable expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Refer to Publication 587, Business Use of Your Home, for more information.

This Web site also contains additional information about business expenses, starting and operating a business and online auction sellers.