Since a hobby is something done for personal pleasure it is not a trade or business, should income be generated from a hobby the gross income is reported on Line 21, Form 1040. The cost of the materials used to make the item sold directly reduces the amount she reports on Line 21.
The definition of gross income is important when determining how much to report as hobby income on Line 21. The regulations permit the taxpayer to reduce that gross income by direct expenses by stating the taxpayer may determine gross income from any activity by subtracting the cost of goods sold from the gross receipts so long as he or she does so consistently. The taxpayer must also follow generally accepted methods of accounting in determining such gross income [Reg. §1.183-1(e)].
Reg. §1.183-1(b) gives ordering rules for the remaining expenses that are otherwise deductible without regard to the activity. Some examples include qualified mortgage interest and property taxes.
Expenses incurred that would be deductible had the activity been engaged in for profit but do not result in a basis adjustment. This includes expenses other than depreciation or amortization, such as contract labor, “business” meals and entertainment, advertising, second phone line, utilities, “business” insurance, etc.
Expenses that are adjustments to basis are then allowed if there is any income left to offset. That means depreciation or amortization.