A common way for aircraft owners to defray the costs of ownership and justify the business use of their planes is through “leaseback” agreements. A leaseback agreement is one in which the aircraft owner agrees to let a flight school – often the same facility or company that sold them the plane – use the plane for their students. The owner takes a small premium over the direct costs of the flight for each hour, which can generate some to modest revenue, depending on the type of plane and the market for flight lessons.
While aircraft owners must concern themselves whether the income this generates is “passive”, there is usually less dispute as to whether the leaseback arrangement is a bona fide business arrangement for purposes of taking business related deductions and allowances, like the Section 179 expensing allowance that produces considerable tax savings in the year in which the plane is placed in service.
The Tax Court, in a Memorandum opinion: Tax Practice Mgmt., Inc., et al. v. Commissioner, TC Memo 2010-266, took exception to the taxpayer’s expensing allowance for lack of a profit motive in its leaseback arrangement. The taxpayer was in the tax preparation business and had offices in multiple states. He testified at trial that his intention in purchasing the plane was to facilitate travel to and from his different offices and support his overall business operations. He stated that he never intended for the leaseback activity to produce more than a small amount of income to offset the plane’s costs.
The court looked to the facts and circumstances of this case in upholding Respondent’s argument that the taxpayer lacked the requisite intent. At the time of purchase, Respondent argued, the taxpayer was in the process of selling the business for which he claimed to have purchased the plane. The Court further noted that the taxpayer used the plane only once in the year in which it was placed in service (late in the year), for a test flight.
Most notable about this opinion was the court’s focus on whether the taxpayer intended to make a profit with the airplane rather than with his tax preparation business. This is an unfortunate decision in that many aircraft purchasers have considerable, bona fide business use for their planes as business tools, and not because they are looking to enter the aviation business per se. The court seemed to place undue emphasis on whether the lease to the flight school was sufficient in and of itself to show the requisite profit motive.
Lesson learned? Here’s a few suggestions: (i) If you’re hot to close on your aircraft purchase prior to the end of the year, stop. The court in the opinion above found the taxpayer’s minimal use of the plane in which the expensing allowance was taken persuasive in accepting Respondent’s argument that there was no “profit motive” in buying the plane. Take your deductions in years for which you can establish a track record of using your plane for business; (ii) Establish in advance, preferably in a written business plan, how the aircraft fits into the business’ overall profit motive. Highlight the differences between the larger business of which the plane is a part, versus the ownership and leasing of the plane as a business unto itself. This is a critical distinction that can save you from a result similar to what occurred in Tax Practice Mgmt.
Ari Good, Esq. practices in aviation tax law, including in defending aircraft businesses and owners in federal income tax and state sales and use tax audits. For more information visit our aviation and tax pages.