Protect aircraft leasing tax deductions from the IRS hobby loss rule.

Owning aircraft through leasing activity is a favorable option for many because of the following 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.

These advantages can get knocked off by the hobby-loss rules that restrict your benefits and call for unfair taxes.

IRS target

The IRS announced earlier this year that it will target private jet usage as part of a larger effort to ensure that high-income taxpayers don’t “fly under the radar” about their tax responsibilities.

Although the announcement is focused on the 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

The hobby loss rule is the silver bullet for the IRS, especially when it comes to killing the deductibility of your business-use aircraft. IRS Section 183 deals with activities not engaged in for profit, and for the years 2018-2025, the IRS can tax the income but disallow all the deductions.

Here is an example: if the IRS determines your aircraft leasing arrangement is for hobby and not business, then the following may happen:

Tax on the gross income from aircraft leasing
Zero deductions for depreciation and operating expenses

For instance, if 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 returns will report $100,000 in taxable leasing income and zero deductions.

The IRS regulations list nine factors determining whether an activity is conducted for profit:

How a taxpayer carries on the activity
The expertise of the taxpayer or his advisors
What is the time and effort spent by the taxpayer on the activity
Expectations of value appreciation of the asset
Success of taxpayer in carrying on similar or dissimilar activities
Taxpayer’s history of income or losses concerning the activity
Amount of occasional profits earned
Financial position of the taxpayer
Elements of personal pleasure or recreation.

No one factor alone determines whether the leasing arrangement is a business or a hobby. But taking this at face value is definitely not good news for aircraft leasing arrangements, as they operate at a loss, have depreciating assets, and have extensive personal usage.

Despite the leasing arrangement structured to lease the aircraft to a profitable related company, it puts the aircraft’s deductibility at risk as the IRS has taken the position that profit motive is determined on an entity-by-entity basis. You have additional tax exposure to position the aircraft as a separate legal entity.

Avoiding the Hobby loss rule

Here are a few options to overcome this downside: Engage qualified tax and legal professionals to ensure your leasing activity meets a few of the abovementioned nine factors. Even the first three factors are enough to hold the IRS’s attempt to reclassify your leasing arrangement as a hobby:

How the taxpayer carries on the activity
Expertise of the taxpayer or his advisors
Time and effort expended by the taxpayer in carrying on the activity

Moreover, you can structure the leasing activity as a single-member LLC within an existing business.

Takeaways

If you lease your aircraft to third parties, you defray some ownership costs
Ownership of the aircraft in a separate entity increases liability protection.
The announcement by the IRS targeting private jets for audits will trickle down and cause IRS examiners to apply the hobby loss rule to more aircraft leasing activities.
Create an LLC to own the aircraft and lease it to your business.