Like many of us, you have probably dreamed of turning your love of aviation into a business. You will not have any unusual tax headaches if your business is profitable. However, if the business consistently generates losses, the IRS may step in and disallow the losses as hobby losses.
There are two ways to avoid the hobby loss rules. The first is to show a profit in at least three out of five consecutive years. The second is to run the venture in a way that establishes a profit motive. The latter continues to receive considerable attention from the IRS.
How can you prove the aviation business was operated to make a profit? The IRS and the courts weigh a variety of factors:
- Manner in which the activity is conducted
- Expertise of the taxpayer and its advisers
- Taxpayer’s time and effort
- Expectation that assets may appreciate in value
- Success in carrying on similar activities
- History of income and loss
- Financial status of the taxpayer
- Elements of personal pleasure
The Tax Court recently reviewed these factors in Heinbockel v. Commissioner, TC Memo 2013-125, and provided a road map of what not to do in establishing your aviation company. In Heinbockel, the Tax Court reviewed whether the taxpayer had the requisite profit motive for his aviation business. In doing so, the Tax Court reviewed the loan documents from the acquisition of the aircraft, the operational projections, the taxpayer’s passion for flying, the company records, the manner of operation, the lack of advisers and industry experts, and the history of losses. After considering all facts and circumstances, the loss deductions were denied and an accuracy related penalty was assessed.
Heinbockel reminds us of the importance of consulting with tax advisors and industry experts before establishing an aviation company. There are numerous organizational and documentary steps that will help establish the aviation company’s profit motive.
IRS Circular 230 Disclosure: Pursuant to IRS Regulations, neither the information, nor any advice contained in this communication (including any attachments) is intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.