Passive Activity Loss

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NBAA Urges Industry Comment on Proposed Passive Loss Restrictions

NBAA Presents Oral Testimony at IRS Hearing on Passive Loss Rule Change
April 7, 2012
John Hoover, chair of the NBAA Tax Committee's Federal Tax Working Group, last week represented the Association at a public hearing on proposed Treasury regulations. The regulations, which would treat certain members of an LLC as limited partners for purposes of passive loss limitations, conflict with congressional intent to encourage investment in business assets, including aircraft, said Hoover, urging the IRS to reconsider elements of the proposed changes. In certain circumstances, these proposed regulations could require that an LLC's aircraft leasing operation be treated as a separate activity for passive loss purposes. The result would be that the LLC's losses, typically consisting primarily of depreciation, could be suspended indefinitely. Review NBAA's Written Comments (81 KB, PDF).

Overview

Proposed Regulations issued by the IRS could have substantial adverse tax consequences to owners of limited liability companies (LLCs) that own or operate aircraft.  The Proposed Regulations would require that an LLC member be classified as a “limited partner” for passive loss purposes, if the LLC’s operating agreement does not state that the member has the right to manage the LLC.  In many cases, LLCs are organized so that the member does not have such rights, and, instead, other individuals, often employees, are designated as the “manager” under the LLC’s operating agreement.  Therefore, the Proposed Regulations would classify many LLC owners as “limited partners” in their LLCs.

NBAA Members impacted by these proposed regulations are encouraged to file comments with the IRS by February 27.

Determine Potential Consequences of the Proposed Regulations

For tax purposes, there are two potentially adverse consequences of being classified as a limited partner in an LLC:

  1. A “limited partner” can only avoid passive loss treatment under 3 of the 7 material participation tests. This limitation is potentially applicable to any LLC, including an LLC that owns, operates, or uses an aircraft.

    This adverse effect can be avoided by “grouping” the LLC’s activities with some other nonpassive operating business for passive loss purposes.  Unfortunately, the second adverse effect below may preclude such grouping when the LLC is the lessor of equipment, such as an aircraft.

  2. A “limited partner” in an LLC that leases equipment such as aircraft is precluded from grouping the LLC’s aircraft leasing activity with any other business for passive loss purposes. By forcing the LLC’s aircraft leasing activity to be treated as a separate activity for passive loss purposes, the Proposed Regulations would cause the LLC’s rental losses (typically consisting primarily of depreciation) to be suspended passive losses for an LLC member classified as a limited partner.

Accordingly, these Proposed Regulations may have substantial adverse tax consequences for LLC members who would answer “yes” to both of the following questions:

  1. Are you a member of an LLC that owns an aircraft?
  2. Does that LLC lease the aircraft to another business in which you own an interest, or to any other party, including an aircraft management company that operates the aircraft to provide charter service?

If you answer “yes” to both of these questions, these Proposed Regulations may cause significant deductions, such as depreciation, to be suspended – perhaps indefinitely – under the passive loss rules. 

In recent years, several federal courts have ruled that LLC members should not be classified as limited partners for purposes of the passive loss limitations.  The IRS’s reaction to these court rulings was to open a project to draft proposed regulations.  At that time, NBAA submitted comments to the IRS requesting that the limited partner classification not be expanded to include LLC members.  Unfortunately, NBAA’s comments were the only comments submitted, and the IRS has now issued Proposed Regulations extending the limited partner classification to LLC members despite NBAA’s comments. 

Therefore, it is critical that as many taxpayers as possible submit comments before February 27th requesting that the IRS not expand the definition of “limited partner” to include LLC members.

Submit Comments on the Proposed Regulations