Protect Aircraft Leasing Tax Deductions from IRS Hobby Loss
Rule Owning an aircraft through a leasing activity is popular for several reasons.
You can defray the costs of ownership by leasing out to a third-party charter company,
defer sales and use tax by purchasing an aircraft and leasing it back to your company, and
own the aircraft in a separate entity for increased liability protection.
Offsetting those upsides, however, are the hobby loss rules that can not only limit your benefits, but cause you to pay unfair taxes.
IRS Target
The IRS came out earlier this year with an announcement that it will target private jet usage as part of a largereffort to ensure high-income taxpayers don’t “fly under the radar” with regard to their tax responsibilities.
Although the announcement focused on personal use of corporate jets, you should expect all IRS examiners to weaponize the hobby loss rule that limits the deductibility of aircraft.
Hobby Loss Rule Explained
The hobby loss rule is the silver bullet for the IRS when it comes to killing the deductibility of your business use
aircraft. IRC Section 183 deals with activities not engaged in for profit and for the years 2018-2025 can tax the income but disallow all the deductions.
For example, if the IRS determines your aircraft leasing arrangement is not a business but is instead a hobby, you will have this undesirable result:
- Tax on the gross income from aircraft leasing
- Zero (or close to zero) deductions for depreciation and operating expenses
Example. Your aircraft-leasing single-member LLC reports $100,000 in leasing income, $300,000 in depreciation deductions, and $50,000 in operating expenses. Your 2024 tax return will report $100,000 in taxable leasing income and zero deductions.
The IRS regulations list nine relevant factors when determining whether an activity is conducted for profit:
It’s important to note that no one factor is determinative on whether a leasing arrangement is a business activity or a hobby. But at face value, it doesn’t look good for most aircraft leasing arrangements, because they
- operate at a loss,
- have a depreciating asset, and
- have extensive personal use by the owner.
Even if your leasing arrangement is structured to lease the aircraft to a profitable related company, it still puts the deductibility of the aircraft at risk because the IRS has taken the position that profit motive is determined on an entity-by-entity basis.4
Essentially, by placing the aircraft in a separate legal entity, you have additional tax exposure.
Avoiding the Hobby Loss Rule
To overcome this pitfall, you have a few options.
First, if having a separate legal entity is a must, you can leverage qualified legal and tax professionals to ensure your leasing activity meets some of the nine factors listed above. For example, the first three factors can be vital in holding off an IRS attempt at reclassifying your leasing arrangement as a hobby.
- Manner in which the taxpayer carries on the activity. Conduct the leasing activity in a businesslike manner, and maintain complete and accurate books and records. Have up-to-date lease agreements, and use standard industry practices.
- Expertise of the taxpayer or his advisors. Consult with competent professionals who deal with aircraft leasing arrangements, including lawyers and tax professionals.
- Time and effort expended by the taxpayer in carrying on the activity. Devoting a limited amount of time to the activity does not indicate a lack of profit motive if you employ competent and qualified persons to carry on the activity.
Second, you can structure the leasing activity as a single-member LLC within an existing business. For example, you operate your medical practice as an S corporation, and you have the S corporation own the LLC that holds the aircraft. The LLC then leases the aircraft to the medical practice. You get the benefits of limited liability protection and sales and use tax deferrals while avoiding the hobby loss rule.
Because the wholly owned LLC is disregarded for federal income tax purposes,6 the separate leasing activity to your medical practice will be deemed disregarded as well. For federal income tax purposes, the aircraft will be deemed to be owned by your business and part of the profitable business operations—therefore sheltering the aircraft from potential hobby loss challenges.
Planning note. The disregarded LLC inside the other entity automatically adds the unified business enterprise theory to the combined entity. You can get the overall unified business enterprise theory result with a totally separate entity, but it’s more difficult.
Takeaways
Here are four takeaways from this article:
