Aircraft rental is passive activity


Failure to properly document material participation prompts a Tax Court ruling that an aircraft rental activity is passive.

The Tax Court held that losses from an aircraft rental activity were passive and could not be used to offset income from other business sources. The ruling was based on the taxpayer’s failure to produce documentary evidence of material participation in the activity.

Facts: Scott Wesley Williams, a part-time lawyer, maintained several businesses during 2007. In addition to his law practice, Williams spent over 2,000 hours as the owner and operator of a telephone skills training business, Worldwide Phone Pops (WPP). He also actively participated during that year in the rental of five properties he owned.

In December 2006, WPP purchased a Cirrus aircraft for use in business travel. Within the same month, WPP entered into a marketing agreement with Sky Blue Flight School to market and rent the Cirrus to pilots and student pilots. The plane was offered for rental by January 2007. Later in 2007, Sky Blue closed, and WPP entered into a new marketing agreement with Mach 1 Aviation Inc. Williams participated in drafting both marketing agreements.

The aircraft rental business generated losses in 2007 that Williams offset against income from WPP by combining aircraft rental income and expenses with WPP’s on a single Schedule C, Profit or Loss From Business. The IRS disallowed the losses as passive and assessed an accuracy-related penalty. Williams petitioned the Tax Court for a redetermination.

Issues: Rental activities are per se passive; thus, taxpayers generally cannot deduct their losses arising from rental activities from nonpassive income. Williams argued that because the Cirrus was rented to each individual pilot an average of no more than seven days, his aircraft activity met the exception of Temp. Regs. Sec. 1.469-1T(e)(3)(ii)(A) for such periods of customer use of tangible personal property. Without deciding whether Williams met the exception, the Tax Court noted that even if he did, he would also have to show he materially participated in the activity.

Material participation is defined in Sec. 469(h)(1) as regular, continuous, and substantial involvement in a business operation. Temp. Regs. Sec. 1.469-5T(a) gives seven tests, any one of which can qualify an individual as materially participating in a nonrental business activity. Williams asserted that he met three of these tests:

1. The individual spends more than 500 hours on the activity in the tax year. Williams asserted that he spent more than 2,000 hours during 2007 running WPP. To make these hours count toward the aircraft activity, Williams argued that WPP and the aircraft activity should be grouped when considering material participation.

2. The individual participates more than 100 hours on the activity during the tax year, and his or her participation in the activity is not less than that of any other individual.

3. Considering all the facts and circumstances, the individual participates in the activity on a regular, continuous, and substantial basis during the tax year. Temp. Regs. Sec. 1.469-5T(b)(2)(iii) clarifies that this test also requires the individual to participate more than 100 hours during the tax year.

Holding: The Tax Court held that Williams failed to establish material participation in the aircraft rental activity. With respect to the first test, the court determined that the aircraft rental activity and WPP did not constitute an appropriate economic unit and thus could not be grouped. Because Williams claimed that he met the 500-hour requirement solely through his participation in WPP, he failed to meet this test. The court also rejected Williams’s argument that he met the other two tests because he failed to properly substantiate the amount of time he spent on the activity. The court observed that Williams made “no attempt to keep contemporaneous records showing what amount of time he spent on the airplane” or provide any corroborating appointment books, calendars, or narrative summaries.

The court also determined that Williams was liable for an accuracy-related penalty under Sec. 6662(a), because, as the language in the aircraft marketing agreements showed, he was aware of the need to meet either the 500- or 100-hour test but failed to keep any records to substantiate that he spent enough time on the activity to meet either test.

- Williams, T.C. Memo. 2014-158

By Raymond C. Speciale, Esq., CPA, associate professor of accounting and law, Mount St. Mary’s University, Emmitsburg, Md., and Ronald D. Golden, Esq., deputy general counsel to the Aircraft Owners and Pilots Association.


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