There is growing evidence of the increasing role of nonfarm activities in the rural livelihoods. However, empirical evidence on the factors that influence smallholder farmers to diversify into nonfarm activities is still scanty. The study analyses the factors that influence household labour allocation decisions and demand for hired farm labour. It was carried out in central, Masaka and southwest regions of the country, which have divergent production constraints and opportunities. The study shows that household members respond positively to increases in shadow wages and negatively to increases in shadow incomes, which implies that they respond to economic incentives. Increase in wage rates negatively affects use of hired labour. Household size has no effect on the use of hired labour, implying that economic rationing of hiring labour has more to do with the market wage than family size and composition. Education and road access have a positive effect on time allocated to off-farm activities. Access to off-farm opportunities, however, takes away the most productive labour from farm production. Investment in road infrastructure, education and financial institutions suited to smallholder production needs could help to alleviate the bottlenecks in the labour, food and financial markets, and improve resource allocation between the farm and nonfarm sectors.