How to Get Aircraft Leaseback Tax Advantages

An aircraft leaseback arrangement, where an owner leases their aircraft to a flight school or charter company, can offer tax benefits. This structure allows a management company to handle operations and marketing while the owner offsets ownership costs. Securing these tax advantages is not automatic and requires strict compliance with Internal Revenue Service (IRS) regulations to prove the aircraft is a business asset.

Operating as a For-Profit Business

To secure any tax deduction, the aircraft leaseback must be a legitimate for-profit business, not a hobby. The IRS applies the “Hobby Loss Rule,” under Internal Revenue Code (IRC) Section 183, to make this determination. If an activity is classified as a hobby, deductions are limited to the income it generates, meaning an owner cannot use aircraft losses to offset other income like wages.

The IRS examines nine factors to determine profit motive. This includes carrying on the activity in a businesslike manner, which involves maintaining accurate books, a formal business plan, separate bank accounts, and formal lease agreements. Another consideration is the expertise of the taxpayer or their advisors; consulting with aviation tax professionals demonstrates a serious intent to be profitable.

The time and effort the owner expends on the activity is also a factor. Even with a management company handling daily operations, the owner should be actively involved in oversight, reviewing financial statements, and making strategic decisions. Other factors include the owner’s history of income or losses, the amount of any occasional profits, and the expectation that the aircraft may appreciate in value.

Maximizing Federal Tax Deductions

Once the leaseback is established as a business, the owner can take federal tax deductions, with depreciation being one of the most substantial. Aircraft are depreciated using the Modified Accelerated Cost Recovery System (MACRS), which allows for larger deductions in the early years of ownership. For aircraft used in commercial charter operations under Federal Aviation Regulation Part 135, the standard recovery period is seven years.

Bonus depreciation allows for an even greater initial deduction. This provision is phasing out, and for an aircraft placed in service in 2025, the bonus depreciation rate is scheduled to be 40%, though this could be altered by legislative changes. For example, on a $1 million aircraft, an owner could take a $400,000 deduction in the first year, with the remainder depreciated over the standard MACRS schedule. To qualify for these accelerated depreciation methods, the aircraft must be used for business purposes more than 50% of the time.

Beyond depreciation, a wide array of operating expenses are also deductible. These include:

• Fuel, oil, and maintenance
• Insurance premiums
• Hangar or tie-down fees
• Interest paid on an aircraft loan
• Payments for professional pilot services
• Subscriptions to aviation publications and training expenses

An alternative to bonus depreciation is Section 179 expensing, which also allows for an immediate deduction of the cost of business property. However, bonus depreciation is often more advantageous for new aircraft, as Section 179 has annual deduction limits that may not cover the full purchase price.

Navigating Passive Activity Loss Rules

The ability to use large deductions is governed by the passive activity loss (PAL) rules under IRC Section 469. The IRS categorizes income and losses as either active or passive. A standard aircraft leaseback is considered a passive activity by default. This means if the aircraft’s deductions exceed its rental income, the resulting “passive loss” can generally only be used to offset income from other passive activities, not active income like W-2 wages.

To deduct these losses against active income, the owner must demonstrate “material participation” in the leasing activity. The IRS provides seven tests for material participation, and meeting just one can reclassify the activity as non-passive. One common test is participating for more than 500 hours during the tax year. Another is met if the owner participates for more than 100 hours, and that participation is more than any other single individual’s.

Proving material participation requires meticulous, contemporaneous records of all time spent on the activity. This includes time spent reviewing maintenance records, analyzing financial performance, negotiating contracts, and physically inspecting the aircraft. If meeting these hourly tests is not feasible, a taxpayer may make a “grouping election,” which combines the aircraft activity with another active business where they already materially participate.

State Sales and Use Tax Exemptions

Beyond federal income taxes, state sales and use tax is a significant financial consideration at the time of purchase. Many states offer a “purchase for resale” or leasing exemption, which can eliminate the upfront sales tax liability. This exemption applies when an aircraft is bought with the explicit intent to lease it to a third party, such as a charter company, which will then collect tax on the rental payments from its customers.

This structure allows the owner to defer the sales tax obligation, paying it over time through taxes on lease revenue rather than as a lump sum. Another common provision is the “fly-away” exemption. This applies when an aircraft is purchased in one state but immediately removed to be based in another. The state of purchase may waive its sales tax if the aircraft leaves within a specified period, often just a few days.

The rules for these exemptions are highly specific and vary dramatically by state. States often impose strict requirements, such as mandating that leasing be the sole use of the aircraft or that the owner obtain a sales tax permit. Consulting with a tax specialist with expertise in aviation and the relevant state regulations is a necessary step.

Essential Recordkeeping for Audit Preparedness

The IRS identifies personal use of corporate aircraft as an area of audit focus, making recordkeeping a requirement for defending a leaseback’s tax benefits. The burden of proof rests on the taxpayer to substantiate every deduction and prove the business nature of the activity.

Key documents include a formal business plan, the executed leaseback agreement, and receipts for every claimed expense. All financial transactions must be kept separate from personal finances by using a dedicated business bank account.

The most important records are detailed flight logs. These logs must contemporaneously document every flight, clearly distinguishing between the owner’s personal use, business-related travel, and revenue-generating flights for charter or rental. This allocation is necessary to pass the greater-than-50% business use test for depreciation. Records should be retained for a minimum of six years after the relevant tax return is filed.