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If you own an aircraft and generate losses from it (through depreciation, loan interest, maintenance, hangar costs, and the dozen other expenses that come with ownership), you might assume those losses are working for you at tax time. For many experienced owners, they’re not.
You fly to client meetings, manage the asset yourself, and take every deduction your accountant recommends. So why are your losses sitting in a box labeled “suspended”?
The IRS defaults to classifying aircraft ownership as a passive activity, which means losses from the aircraft can only offset passive income. Not your W-2 salary, not your active business income, and not your investment portfolio gains. If you don’t have enough passive income to absorb those losses, they don’t disappear. They get “suspended” and carried forward indefinitely, piling up year after year. If you’re not on top of your own paperwork, you may not even notice it.
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This is one of the most consistently misunderstood aspects of aircraft ownership, and it catches experienced pilots every year, even business owners who work with dedicated accountants. The passive activity loss (PAL) rules were built specifically to limit this kind of deduction, and without careful planning, your aircraft’s biggest financial benefit on paper can become a benefit you never actually collect.
The passive activity loss rules were introduced as part of the Tax Reform Act of 1986, and they were deliberately designed to shut down a tax shelter industry that had exploded throughout the late 1970s and early ’80s. High-income professionals were being sold interests in cattle ranches, oil drilling ventures, and other paper-loss-generating enterprises.
The tactic involved, on paper, generating large accounting losses through depreciation and expenses, and those losses were in turn used to reduce taxes on salary.
Congress saw it for what it was and passed Section 469 to force taxpayers to sort their income and losses into three separate buckets: active income, passive income, and portfolio income. The new rule meant that losses from the passive bucket could only offset income from that same bucket. Aircraft ownership, particularly when the owner doesn’t meet a fairly demanding set of participation requirements, has since fallen squarely into the passive category.
Here are five common mistakes that aircraft owners make when it comes to passive loss and tax deductions:
1. Assuming Business Use Equals Active Loss
This is the most widespread error in aircraft taxation, and it trips up experienced owners who should know better. Flying your aircraft to client meetings, hauling your sales team to trade shows, or using it for your construction company’s site inspections does not, by itself, make your aircraft losses deductible against your regular income.
For your losses to be treated as active (nonpassive), the aircraft activity itself must meet one of the IRS’ seven material participation tests. The most commonly cited test requires that you personally participate in the activity for more than 500 hours during the tax year. Other tests allow you to qualify if your participation constitutes substantially all of the participation in the activity, or if you participate more than 100 hours and no other person participates more than you do.
Here’s where owners get into trouble: most pilots fly 200 to 300 hours a year. That alone won’t get you to material participation. Note, if you have a flight department, management company, part-time pilot, or any other person meaningfully involved in the operation of the aircraft, the IRS will likely use their participation to dilute your claim. The regulation counts participation by all individuals, including non-owners.
2. The Charter Offset Trap
Putting your aircraft on a Part 135 charter certificate is a popular way to offset operating costs, and it’s a legitimate strategy. But it introduces passive activity complications that you might not anticipate.
When your aircraft is leased to a charter operator or used in a dry lease arrangement (a lease without a flight crew), that activity is generally treated as a rental activity, which is per se passive under Section 469(c)(2) regardless of how much time you spend managing it. The rental rules under Section 469 don’t care about material participation the way trade or business activities do. The passive classification applies automatically unless a specific exception applies.
One such exception: If the average period of customer use is seven days or less, the activity may be treated as a business rather than a rental, allowing material participation to come back into play. But even then you must separately demonstrate that you meet one of the seven participation tests.
Many owners who charter their aircraft end up with two separate passive activity buckets: one for the charter/rental activity and one for the personal business use. Losses from each can generally only offset income from the same category.
3. Inadequate Documentation
Even owners who legitimately qualify for material participation sometimes can’t prove it when the IRS asks. Courts and the IRS expect contemporaneous records: documentation created at the time of the activity.
Your pilot logbook is a starting point, but it’s not enough. The IRS looks for records of time spent managing the activity in ways that go beyond flying: coordinating maintenance, reviewing invoices, communicating with the management company, evaluating insurance, planning flight schedules, overseeing charter operations if applicable, and other management-level participation. Without a system that captures this work in real time, you’ll probably be unable to substantiate a material participation claim even when the underlying facts are on your side.
The National Taxpayer Advocate has specifically highlighted substantiation failures as a leading cause of taxpayer losses in passive activity loss litigation. In review of 28 published court opinions on PAL issues, courts repeatedly found that taxpayers failed because they did not keep logs or did not know the required hours needed.
4. Ignoring the Grouping Election
One of the most powerful and most overlooked tools in aircraft tax planning is the grouping election under Treasury Regulation Section 1.469-4. If you own a business that uses your aircraft, and both the aircraft activity and the business share the same proportionate ownership, you may be able to group them together and treat them as a single activity for material participation purposes. This can dramatically lower the threshold for demonstrating that you materially participate by combining hours across both activities rather than evaluating each in isolation.
The problem is that this election is almost never made proactively. Owners either don’t know it exists, or their general-practice accountant isn’t aware of the specific rules that allow aircraft activities to be grouped with operating businesses. The election also must be made in a manner that is consistent from year to year, and once made (or improperly omitted), unwinding it is complicated. To get the most out of it, you need to make this election correctly at the time of purchase.
It’s also worth noting that a grouping election isn’t the right move in every situation. If the aircraft activity actually generates income in some years, or if the business activity has its own passive loss issues, grouping could produce unintended consequences. This is exactly why the election requires analysis from an advisor who understands both sides of the equation.
5. Mishandling the Disposition
Under Section 469, when you fully dispose of your interest in a passive activity in a fully taxable transaction with an unrelated party, all of your suspended losses from that activity become deductible in the year of disposition. If you’ve accumulated significant depreciation-driven losses over multiple years, that can mean a pretty substantial deduction.
Most competent tax advisers will catch the deduction at sale. The mistake is failing to plan around the event. Owners who sell their aircraft without thinking about when and how the disposition occurs often give up the opportunity to time the transaction alongside a year with elevated income, which could make the deduction significantly more valuable. Alternatively, they may fail to structure the sale in a way that clearly constitutes a fully taxable disposition to an unrelated party.
This planning conversation should happen before you decide to sell, not after. If you’re sitting on a meaningful amount of suspended passive losses, your exit strategy deserves the same level of attention as your purchase structure.
How to Handle Audit Risk
All of the above happens against a backdrop of increased IRS scrutiny. In February 2024, the agency announced it would significantly increase audits of business aircraft use by corporations, partnerships, and high-income individuals, all as part of a broader initiative funded by the Inflation Reduction Act. The IRS acknowledged it had not closely scrutinized this area in over a decade, and made clear it was making up for lost time.
Aircraft deductions have historically attracted IRS attention because the dollar amounts involved are large, the rules are complex, and the line between legitimate business use and personal benefit is frequently blurred. Large depreciation deductions in the first years of ownership, especially in combination with things like charter income and passive activity elections, create a pattern that IRS agents are specifically trained to examine.
There’s a clear through line in every one of these mistakes, which is that they’re all preventable. There are a handful of steps you can take to cover all of your bases with passive loss rules:
- If you don’t already, make sure to work with a CPA or tax attorney who has specific aviation experience.
- Establish a real-time documentation system from day one (cover management time, vendor coordination, maintenance oversight, and other activities that count toward material participation).
- Evaluate the grouping election at the time of purchase.
- Understand the charter implications before placing your aircraft on a Part 135 certificate.
- Model out the suspended loss scenario before you buy, so you have a realistic picture of what your deductions are actually worth.
- Plan your exit before you sell if you have meaningful accumulated passive losses.
Check out Aircraft For Sale for a huge selection of classic and modern aircraft, and if you want to learn more about your financing options for your next aircraft, talk to us at FLYING Finance today and our team of experts will be happy to answer any questions.
