A taxpayer was denied current deductions and a net operating loss arising from his claimed business related to a restored vintage World War II fighter plane in the case of Kurdziel v. Commissioner, TC Memo 2019-20.  The Tax Court agreed with the IRS that the losses were barred by what is referred to as the hobby loss rule under IRC §183.

IRC §183(a) provides:

(a) General rule

In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section.

Mr. Kurdziel is a commercial airline pilot and engineer who found a rare vintage World War II aircraft that he restored.  The aircraft, a Fairey Firefly, went into service late in World War II.  As such, many fewer of this aircraft were built than were built of aircraft that were used throughout the war.  In 1993 the taxpayer acquired one of the few remaining Fireflies.

The aircraft was no longer in a condition where it could be flown—in fact, at that point in time there were no remaining Firefly aircraft that were still flight worthy.  Mr. Kurdziel had to create replacement parts on his own, and eventually was able to restore the aircraft to the point where the FAA issued an air worthiness certificate.  He also was able to obtain a license to fly the plane.

Acquiring and restoring the aircraft was not an inexpensive undertaking.  Mr. Kurdziel ended up with a cost basis in the aircraft of approximately $1.6 million.

He initially believed he would make money off the aircraft by selling rides on the vintage plane.  But he discovered FAA regulations would make that impossible. 

He also took the plane to airshows.  When he initially completed the restoration, the plane attracted significant attention and won prizes.  It won the title of grand champion at the nation’s premiere airshow in Oshkosh, Wisconsin and won another such prize at the National Aviation Heritage Invitational in Reno, Nevada.

Sometime after the restoration was completed Mr. Kurdziel began reporting an airplane leasing business on his personal tax returns, claiming losses in excess of $100,000 from the business in each of the years before the Tax Court. The term “airplane leasing” was not a correct description of the business as Mr. Kurdziel never leased the aircraft to any other party.  What income the business had arose from prizes from appearing at air shows.

While depreciation made up a significant amount of the loss (about $80,000 per year), the income Mr. Kurdziel received in each year never came close to covering the year’s cash out of pocket expenses.

Not surprisingly, the IRS challenged the losses, claiming that this was merely an expensive hobby being carried on by the taxpayer, with the expenses used to offset other income.

The Tax Court noted that Reg. §1.183-2(a) provides a nine-factor test that is used to determine if an activity is carried on with the required profit motive.  This test has been subject to criticism, with the Seventh Circuit Court of Appeals referring to the test as “goofy” when it rejected the test and used a more general approach.[1] 

But the Tax Court notes that this case is appealable to the Ninth Circuit Court of Appeals which has not indicated that it would reject the “goofy” standard.  So, the opinion notes that the nine tests still would be used to analyze Mr. Kurdziel’s motive in this case.  The nine tests are:

• The manner in which the taxpayer carries on the activity;

• The expertise of the taxpayer or his advisors;

• The time and effort expended by the taxpayer in carrying on the activity;

• The expectation that assets used in the activity may appreciate in value;

• The success of the taxpayer in carrying on other similar or dissimilar activities;

• The taxpayer's history of income or losses with respect to the activity;

• The amount of profits earned, if any;

• The financial status of the taxpayer; and

• Any elements of personal pleasure or recreation.

The Court found most of the tests either clearly favored the government or were neutral.  But the Court did note that such aircraft did have substantial value that Mr. Kurdziel was aware of and that it was possible the aircraft could be sold for a gain that would allow Mr. Kurdziel to recover both the costs of the restoration and the operating costs as the plane was shown at airshows in order to gain exposure.

But the Court found that this possible appreciation did not override the other factors in this case—Mr. Kurdziel did not have a clear business plan for the plane (noting the “airplane leasing” description), did not change what we was doing when he discovered he could not sell rides on the aircraft as he initially planned, and clearly just enjoyed restoring and flying this unique aircraft.

The Court then decided that even under the Seventh Circuit’s standard the taxpayer would fail to show a profit motive, because his overall actions weren’t consistent with a taxpayer looking to make money off selling the plane.  The Court pointed out that the aircraft today is no longer airworthy, being involved in a crash in 2012—a very real risk when flying such vintage aircraft.

The opinion notes:

Given the risks that Kurdziel admitted are associated with flying the Firefly, we find it suspect that he didn’t try to sell it. We can reasonably see him holding the Firefly for a few years after restoration to enter airshows and increase exposure. But Kurdziel didn’t seem to even think of selling it in the years before us, and affirmatively represented to local tax authorities that he didn’t intend to do so.

He instead continued to hold the plane for nearly 15 years after its restoration was complete and it was awarded grand champion titles — a time when it was arguably at its most valuable — all while using the considerable expenses of its upkeep to offset his significant other income.

Thus, the Court concludes that Mr. Kurdziel lacked a profit motive in his “aircraft leasing” business.

[1] Roberts v. Commissioner, 820 F.3d 247, 250, 254 (7th Cir. 2016), rev’g T.C. Memo. 2014-74.