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Hobby Losses - Cases and Rulings

Morton v. United States, 107 A.F.T.R. 2d Par. 2011-1 U.S.T.C.

Peter Morton, co-founder of the Hard Rock Café, owned and/or controlled several businesses related to the Hard Rock Café. One of these entities was a subchapter S corporation that owned and operated a Gulfstream jet. This S corporation was not profitable. However, the aircraft was used in connection with the profitable businesses of his other holdings.

The IRS took the position that the S corporation operating the Gulfstream was a “hobby” as per Sec. 183 of the Internal Revenue Code. Morton countered that he should be able to deduct all aircraft related expenses because all of his businesses were part of a “unified business enterprise” that should be looked upon as an aggregate.

The court ruled in favor of Morton on the hobby loss issue. In its ruling, the court stated that the “unified business enterprise” theory was applicable. The court further held that “[a]s long as [Morton] used [the aircraft] to further a profit motive in his overall trade or business, the deduction is allowed.”

Rabinowitz v. Commissioner, T.C. Memo 2005-188

In this case, the Tax Court wrestled with the question of whether a separate company operating an aircraft in an unprofitable charter business should be evaluated independently of its owner’s profitable clothing business when determining whether hobby loss rules apply to the air charter business. In making its determination, the Tax Court considered the following nonexclusive set of factors from Treasury Regulation Section1.183-2(b):

  1. Whether the undertakings share a close organizational and economic relationship;
  2. Whether the undertakings are conducted at the same place;
  3. Whether the undertakings were part of the taxpayer’s effort to find sources of revenue from his or her land;
  4. Whether the undertakings were formed as separate businesses;
  5. Whether one undertaking benefited from the other;
  6. Whether the taxpayer used one undertaking to advertise the other;
  7. The degree to which the undertakings shared management;
  8. The degree to which on caretaker oversaw the assets of both undertakings;
  9. Whether the taxpayer used the same accountant for the undertakings; and
  10. The degree to which the undertakings shared books and records.

In Rabinowitz, the Tax Court ruled that the clothing and aircraft charter businesses should not be treated as one activity for the purpose of applying the hobby loss rule. Nonetheless, the court did rule that the aircraft charter business established with a principal purpose and intent of generating a profit. Therefore, the hobby loss rule was not applicable.

Campbell v. Commissioner of Internal Revenue, 868 F.2d 833 (1989)

Campbell was a shareholder in Health Care Corporation (HCC), a corporation located in Chattanooga, Tennessee, and formed to invest in and develop psychiatric health care facilities. In pursuing its business, HCC officers and employees engaged in extensive air travel. In 1978, after airline deregulation, commercial air service to Chattanooga was seriously curtailed. HCC took this opportunity to form a partnership called Health Air, which purchased an aircraft (a 1979 Beechcraft) that could be used by HCC officers and employees and the general public. Health Air leased the airplane to HCC and a local fixed base operator. During its years of operation (1979-1982), the partnership incurred losses that were in large part due to depreciation. However, in 1984 Health Air had a substantial profit on the sale of the aircraft.

The IRS denied Campbell's share of Health Care partnership losses. The Tax Court sided with the IRS, stating that the sole motivation of the Health Air partnership was to provide HCC with air transportation and generate "paper losses" for Health Air's partners. The U.S. Court of Appeals reversed the Tax Court, stating that the Tax Court failed to recognize the honest and objective profit motive of Health Air indicated by the facts presented in the record. The Court of Appeals went on to state that the fact that losses occurred does not, in itself, create a presumption that the partnership lacked profit motive. In this case, other factors such as substantial increases in fuel prices, inflation, and interest rates (which rose sharply right after Health Air's purchase of the aircraft) contributed greatly to the losses. Finally, the Court of Appeals stated that the Tax Court could not ignore the fact that Health Air recognized a substantial profit when it sold the aircraft in 1984. The Court stated that the Tax Court could not properly focus solely on losses generated in large part by depreciation while at the same time ignoring gains realized on the sale of the aircraft that were in large part due to depreciation.

Sislik v. Commissioner of Internal Revenue, T.C. Memo 1989-495

Sislik was a pilot for Pan American. In 1979, Sislik and a fellow pilot, Robert Taylor, met with a group of former Pan Am executives who had formed a commuter airline named Transtate. At the time of the meeting, the airline industry was undergoing deregulation and the outlook for commuters was favorable. After the meeting, Sislik, Taylor, and one of the Transtate executives decided to purchase two Britten Norman Islander aircraft for lease to Transtate. The men discussed the profit potential, and each made a separate estimate of expected profits. The men were unable to jointly finance the purchase of the planes, and Sislik decided to establish on his own an S corporation, Michal Rakus, Inc., and buy one Britten aircraft through the corporation. During 1980, Rakus leased the plane to Transtate for $80 a flight hour, with Transtate to pay all fuel and maintenance expenses. Although Rakus had gross income in 1980 of $7,171 from leasing the plane, the corporation had an overall loss of $35,179, which Sislik claimed on his individual tax return. In late 1980, Transtate went out of business and its lease with Rakus was terminated. In 1981, Michal Rakus, Inc. merged with another S corporation, Rakus & Sons, of which Sislik was again the sole shareholder. Rakus & Sons attempted to lease the planes, with little success. On his tax returns in 1981 and 1982, Sislik claimed losses of $79,988.86 and $81,236.97, respectively. The IRS disallowed the deductions on the grounds that the aircraft leasing business was not entered into for profit but was, instead, designed to generate tax savings for Sislik.

The Tax Court disagreed with the IRS and ruled for Sislik. The court rejected the IRS's argument that Sislik had a cavalier approach to the leasing business because he was not involved in its day-to-day operations. The court stated Sislik had no daily responsibilities, because he leased the aircraft to a commuter airline that was responsible for its maintenance and operation. Sislik periodically inspected the plane and made reasonable efforts to keep it leased. The court found the inability to locate new lessees was due to the air traffic controller strike that adversely affected the commuter industry in the summer of 1981. The court noted that although Sislik had no previous experience in aircraft leasing, he had been an airline pilot for 14 years and had consulted with former Pan Am executives who were experienced in the airline industry. The court found no evidence that Sislik engaged in the leasing activity to generate tax losses. Sislik's initial profit projections were not based on any tax savings, and Sislik attempted to minimize losses when he was unable to lease the plane.

Keenan v. Commissioner of Internal Revenue, T.C. Memo 1989-300

Keenan, a pilot for United Airlines, purchased an Aerotek-Pitts S-2A aerobatic airplane in November 1977. From 1979 through 1984, he leased the plane for aerobatic instruction. Keenan was responsible for the costs of fuel, maintenance, hangar space, and insurance. During 1981-1982, the costs of insurance and fuel increased dramatically, making it difficult to realize a profit from the lease of the plane. Keenan kept no records of income from the lease of the plane. The various lessees kept a log of flight time spent in the Pitts and periodically sent Keenan checks. When the lessees incurred expenses associated with the aircraft, the lessee would bill Keenan or deduct the amounts from the checks sent to him. Keenen kept an account with Shell Oil for lessees to charge fuel. He rarely flew the plane for personal use. Keenan deducted the costs associated with the purchase and lease back of the Pitts on his income tax return. The IRS disallowed the deductions. Keenan petitioned to the Tax Court, which held that he engaged in the lease of the Pitts for profit. The court found that Keenan's informal record keeping was sufficient. Keenan used canceled checks as his expense records; and Hobbs meter readings from the aircraft corroborated his reported earnings and expenses, except with regard to 1982, when the court found Keenan underreported his income. Keenan had some knowledge in the aviation field and leased to skilled pilots, one of whom owned a Pitts dealership. The court noted that although the escalating price of fuel and insurance precluded Keenan from earning a profit, the lease backs consistently generated income. In conclusion, the court held that Keenan's airplane activity was not recreational, nor was it used to produce large non-cash expenditures such as depreciation, to shelter his income.

Bacot v. Commissioner of Internal Revenue, T.C. Memo 1989-77

Bacot worked for an oil company and as a police officer during 1980. In addition, he had a consulting business named Bacot Confidential. According to Bacot, he assisted clients in preparation for tax audits. Bacot owned a Cessna, which he sold in August 1980. In the following month, Bacot bought a 1978 Mooney for $50,000. On Schedule C of his 1980 tax return, Bacot reported a net loss of $11,648 associated with Bacot Confidential. Some of the income from the consulting business was generated by charter flights in the Cessna and Mooney. In addition, Bacot claimed depreciation deductions on the aircraft. On Schedule E of the return, Bacot reported rental income from the aircraft. Additional aircraft depreciation and expenses associated with the rentals resulted in a net loss from this activity. Finally, Bacot claimed an investment tax credit on the Mooney. The IRS disallowed all of the claimed business expenses and aircraft depreciation on Schedule C relating to the operation of Bacot Confidential. The IRS determined Bacot undervalued the rental income on Schedule E, and disallowed a portion of the expenses and depreciation. Finally, the IRS disallowed the investment tax credit on the Mooney.

Before the Tax Court, Bacot asserted he was involved in confidential counseling of clients in tax matters and that this business necessitated extensive travel. Since he resided in Alaska and air travel was the primary mode of transportation in Alaska, Bacot claimed the aircraft were a necessary and ordinary business expense. The Tax Court found that Bacot failed to meet his burden in demonstrating he was involved in the consulting activity for profit. Less than half of the income reported on the Schedule C was generated from the tax consulting business, and that income was received from only one client. The court further found that Bacot failed to prove the chartering business was engaged in with any regularity for the purpose of generating profit. Bacot submitted part of his pilot's log to substantiate his claims. Three of the twelve flights generated income reported on the Schedule C. The remaining nine flights were unexplained. The court also held that the IRS properly disallowed depreciation of the aircraft based upon the 200% declining balance depreciation method, since Bacot was not the first user of the aircraft. The court determined that the 150% method was appropriate. Finally, the court upheld disallowance of the investment tax credit, since Bacot failed to present evidence as to the prior use of the Mooney.

Kartrude v. Commissioner of Internal Revenue, T.C. Memo 1988-498

Gordon Kartrude, a flight engineer for Pan Am, and his wife were the sole shareholders of an S corporation, Sport Aircraft, Inc. In 1976, Kartrude was laid off by Pan Am. During 1978, Kartrude began using a Pitts, owned by Sport Aircraft, to perform stunts at air shows and to give aerobatic flight instruction. He promoted his services by advertising in newspapers, traveling to air shows, and placing a sign by the Pitts. In 1978, Sport earned revenues of $5,437.56 but incurred expenses of $10,689.24, including $536.09 for advertising. In 1979, Sport was paid $11,000 for stunts performed by Kartrude in a movie. Kartrude also acted as a technical consultant for the movie. In 1979, Kartrude's flying partner, with whom he had been flying dual formations at air shows, moved out of the country. This event impaired Kartrude's ability to perform at air shows. In 1980, Kartrude worked at Burnside OTT Aviation as a flight instructor; and Sport's revenues declined to $1,061, while expenses equaled $7,907.79. Only $42 was spent on advertising. In 1982, Pan Am rehired Kartrude, and Sport received no revenues, while incurring expenses of $849.32. Sport spent no money on advertising. The IRS disallowed Kartrude deductions on his individual tax returns for the losses generated by Sport.

After reviewing the facts of the case, the Tax Court held that Kartrude possessed a profit objective in 1978 but lost the objective before 1980. In 1978, Kartrude promoted the stunt flying activities, as was evidenced by the $536 expended on advertising. During this time, Kartrude kept a separate checking account for Sport and a flight log of activities. He spent considerable time in the business through 1979, when he performed stunts in the movie. The court noted that during this period Kartrude had lost his flight engineer job and did not earn substantial income. The court found this evidence to undercut the IRS position that the flying activities constituted a hobby. The court, however, found Kartrude lost the profit motive in 1980 after his flying partner left the country. Kartrude began working full time for others and was unable to devote sufficient time to Sport. The court also pointed to the decline in advertising revenues after 1979.

Williams v. Commissioner of Internal Revenue, T.C. Memo 1987-308

John Williams was a private pilot and had owned several aircraft. In 1981, he met David Lindsey, who owned and operated a thriving air charter business at a local aircraft. Lindsey wanted to add a cargo plane to his fleet of aircraft. He persuaded Williams and Richard Bonner to purchase a Cessna 185 for use in the charter business. Williams and Bonner bought the plane in August 1981; but due to needed repairs, the airplane was not available for commercial operations until December 1981, at which time Lindsey began promoting charters for it. In April 1982, Lindsey and most of his pilots were killed in a plane crash. After Lindsey's death, the charter business at the airport decreased dramatically and the Cessna was minimally used. Williams deducted losses associated with the Cessna from his 1981-1983 income taxes. The IRS disallowed the loss for 1981 on the basis that the Cessna activities were not engaged in for profit.

The Tax Court disagreed with the IRS and found that Williams engaged in the charter activities with a profit objective. In purchasing the Cessna for charter, Williams relied on the expert advice of Lindsey, who ran a successful charter business. Under the arrangement, Lindsey was to contact prospective lessors, arrange the charters, and hire the necessary pilots. In the initial year, the Cessna was not available for charters, due to needed service; yet Williams incurred all the expenses associated with aircraft ownership. The court found that this initial loss did not indicate a lack of profit motive. The Tax Court also concluded that the 1982 and 1983 losses were caused by the unexpected death of Lindsey. Williams's failure to maintain extensive records was not deemed significant, since the charter activities never flourished. The court noted that the Cessna 185 was noisy, difficult to fly and best suited to carry cargo, not people, making it an unlikely pleasure aircraft. Further, Williams owned another aircraft more suited for personal flying that he used during the tax year in dispute.

Cornfeld v. Commissioner of Internal Revenue, 797 F.2d 1049 (1986)

Cornfeld was the president of a financial conglomerate that managed $2.5 billion in assets and employed 25,000 sales representatives in 100 countries. In 1968, Cornfeld purchased several aircraft, including a Falcon jet, a Convair 220, and a Jet Commander. He also obtained a 25% interest in an aircraft leasing company, Aeroleasing. Cornfeld paid a monthly fee to Aeroleasing in exchange for advertising and chartering services. In 1969, Cornfeld bought a BAC 1-11 jet from British Aircraft Corporation. Cornfeld took delivery of the aircraft in September 1969, but BAC retained possession until October 31, 1969, because the jet was under lease to another company. Cornfeld received a $50,000 deduction from the $4.5 million purchase price, in light of the lease arrangement. The jet was then scheduled to be refurbished and delivered to Cornfeld in February 1970.

However, BAC informed Cornfeld that delivery would be delayed until June 1970. Before delivery, Cornfeld was removed as president of the conglomerate. Consequently, Cornfeld was unable to complete the BAC transaction and he defaulted on the purchase agreement. On his 1969 and 1970 tax returns, Cornfeld claimed losses relating to his aircraft leasing activities. The IRS disallowed the deduction on the basis that the activities were not engaged in for profit. Before the appeal to the Tax Court, the claims involving all the aircraft except the BAC 1-11 jet were settled. The Tax Court subsequently ruled that the BAC jet was not acquired for business purposes and, even if it had been so acquired, the aircraft was not placed in service in the tax years 1969 or 1970. Cornfeld appealed to the D.C. Circuit Court of Appeals.

The Court of Appeals found that Cornfeld had an "actual and honest profit objective in pursuing the activity in question." The court noted that the aircraft chartering activity was not a hobby disguised as a business. Cornfeld was not a pilot and did not "amuse himself by collecting aircraft." The court found that Cornfeld had a knack for making money and that he acquired the fleet of planes for use in his business and for lease to the public. He hired Aeroleasing to advertise and arrange the charter services. Under a separate agreement covering the BAC jet, Aeroleasing was placed in charge of the maintenance of the aircraft and had hired six pilots to operate the plane. The Court of Appeals also rejected the Tax Court's conclusion that the remodeling of the aircraft to seat half as many passengers as originally configured demonstrated a lack of profit motive. The Court of Appeals stated that the Tax Court should not second-guess business decisions. "The test is the taxpayer's subjective intent, not whether a reasonable businessman would have done the same." Finally, the court determined that the aircraft was placed in service when Cornfeld took delivery of the jet in September 1969. Although Cornfeld returned the jet to BAC to fulfill the outstanding lease obligations, Cornfeld obtained an economic benefit, a $50,000 credit toward the purchase price.

Mueller v. Commissioner of Internal Revenue, T.C. Memo 1985-450

Mueller received his private pilot certificate on September 20, 1979, and seven days later he purchased a Piper Warrior. Mueller arranged for Bates Aviation, Inc. to act as a rental agent for the airplane, which was to rent for $27 an hour. Mueller was to receive $14 an hour from the rentals, and he was responsible for the insurance, fuel, oil, and tie-down. Mueller rented the airplane once in October 1979 before the plane received a complete overhaul. The aircraft was not available again for rent until December 16, 1979. At that time, the aircraft was flown for a potential customer. Later that month, Mueller flew to Baja, California, and Mexico with a friend and returned January 2, 1980. In 1979, Mueller received no income from the rental of the Piper, and in 1980 and 1981 he received rental income of $2,988 and $2,430, respectively. In all three years, Mueller's expenses exceeded income generated by the aircraft. Mueller deducted the losses and took an investment tax credit on his 1979 income tax return. The IRS disallowed the credit and the deductions except for taxes and interest.

The Tax Court agreed with the IRS's argument that Mueller's aircraft rental activities were not a trade or business engaged in for profit. The court stated that in order for an activity to constitute a trade or business, "the activity must be entered into in good faith with the dominant hope and intent of realizing a profit...Whether the taxpayer possesses the required profit motive or intent is a question of fact to be decided based on all the evidence in the particular case...In making this determination, more weight must be given to the objective fact than to the mere statements of the parties." Applying the nine factors set forth in Section 1.183-2(b) of the Income Tax Regulations, the court found that during 1979, Mueller was the only person to fly the Piper, other than flights made for maintenance purposes. The court disapprovingly noted that Mueller had attempted to deduct as an advertising expense the costs of his Baja and Mexico trip, which he took with a non-pilot friend. The court concluded by finding that Mueller derived a great deal of pleasure from flying and "the rental activity was a means of subsidizing what was a basically personal expense."

Louismet v. Commissioner of Internal Revenue, T.C. Memo 1982-294

Louismet, who held a commercial pilot certificate, and his wife purchased a Cessna Citation jet in July 1974. The couple previously owned a Cessna 402A which they leased out. Before taking delivery of the Citation, Louismet hired a co-pilot, and both men were certified in the aircraft. Louismet also contacted two large corporations about leasing the jet. The corporations, however, purchased their own Citations. After conferring with Cessna personnel and determining what others charged for the leasing of similar aircraft, Louismet set a leasing rate of $500 per hour. In 1974, the Citation had only one paid charter.

In late 1974, Louismet and Ronald Henriquez set up a company for the purchasing and selling of commodities. The company was based in the Grand Cayman Islands and Aruba. The men agreed that the company would lease the jet at a rate of $500 an hour, and after October 1974 all flights were undertaken in association with the commodities business. On his 1974 tax return, Louismet claimed deductions related to the aircraft activities. The IRS disallowed the deductions, except to the extent of income derived from the aircraft activities, on the basis that the activities were not engaged in for profit.

The Tax Court determined that Louismet was engaged in two separate activities: aircraft chartering and the importing of commodities. As to the chartering activity, the court noted that although Louismet was a man of means, the investment of $764,968 in the Citation was a considerable sum of money to him. The court found that Louismet could not afford a hobby of such dimensions. The court further stated that Louismet had taken steps to charter the aircraft following its purchase and did in fact charter the jet soon after its delivery. The court found that one reason Louismet entered the commodities business was to secure a lease for the Citation. Based upon these facts, the court held that Louismet engaged in the chartering business for profit.

Akers and Hamrick v. Commissioner of Internal Revenue, T.C. Memo 1981-627

In 1976, Drs. Akers and Hamrick formed a partnership involving a Cessna 172. The stated purpose of the partnership was to sublease the aircraft for profit. Soon thereafter, the partnership traded in the Cessna for a Bonanza. In 1976 and 1977, Akers, Hamrick, and other pilots rented the aircraft at a set hourly rate. In 1978, the partnership entered into a lease back arrangement with Air Services, Inc., an FBO at the local airport. The FBO secured customers for the aircraft and paid the partnership a fixed amount based upon the hours the aircraft was used. Akers and Hamrick were charged the same rate as other customers. In late 1978, the partnership traded in the Bonanza for a Baron and maintained the same lease back arrangement with the FBO. The partnership suffered losses in 1976 through 1978, and Akers and Hamrick deducted these losses from their personal income tax. The IRS disallowed the deductions on the ground that the partnership was not engaged in the renting of aircraft for profit.

In upholding the IRS ruling, the Tax Court noted that the partnership suffered a series of losses. The court recognized that losses, in themselves, are not conclusive evidence that an activity was not engaged in for profit but found Akers and Hamrick "introduced no evidence to demonstrate that it is customary or necessary in the aircraft rental business to suffer losses for three years to build a profitable business." The court also found the partnership did not operate in a businesslike manner. Akers and Hamrick spent a minimal amount of time marketing the partnership aircraft despite repeated losses, had no office or phone, spent no money on advertising, and failed to establish a guaranteed minimum rental charge. The court noted that Hamrick took the plane for fourteen days in 1976 but had incurred only 4.1 hours of rental charges. Aircraft rental operators routinely utilized a minimum use policy with rental aircraft, and the president of Air Services testified that his company would have objected if a customer rented a plane for a 14-day trip but incurred such limited flight time. The court further found that the planes owned by the partnership were too complex and expensive for the local rental market, which was composed primarily of flight training. Finally, the court found that Akers's and Hamrick's personal and recreational use of the aircraft also demonstrated the operation of the planes was not engaged in for profit.

Worley v. Commissioner of Internal Revenue, T.C. Memo 1980-51

Dr. Worley was employed as a surgeon by the Carl M. Worley, M.D., Plastic & Reconstructive Surgery, Ltd. (the Worley Corporation). He also was the corporation's sole shareholder. In 1972, Dr. Worley purchased an Aerostar 600. From 1972-1977,Worley leased the Aerostar to the Worley Corporation for his professional travel and leased the plane to himself for personal travel. During these flights, Worley piloted the aircraft. He also occasionally leased the Aerostar to others for air charter work. Expenses from the operation, maintenance, and housing of the Aerostar exceeded the gross income attributable to the plane, and Dr. Worley deducted these losses on his personal income tax return. The Internal Revenue Service disallowed the deductions on the basis that the aircraft leasing activities were not engaged in for profit.

In ruling for the IRS, the Tax Court stated that such deductions were allowable only if "the taxpayer had a bona fide, even though unreasonable, objective of making a profit" from the activity. "The determination of the taxpayer's intent is to be based on 'all facts and circumstances' with respect to the activity, with greater weight placed on objective facts than on the taxpayer's statement of intent." The court considered the facts surrounding the leasing of the Aerostar in light of the nine factors listed in Section 1.183-2(b) of the Income Tax Regulations. Although Dr. Worley maintained separate bank accounts and records for the leasing activities, filed appropriate legal papers for obtaining a business name, and established leasing rates for air charters and the Worley Corporation, the court found Worley did not operate the activity in a businesslike manner. For example, the court stated that Worley failed to obtain a definite guarantee of minimum charges from any lessee, did not change the pricing structure after repeated yearly losses, failed to insure the air taxi operations, and maintained no office or phone number. Noting that the ratio of average annual expenses to annual average gross receipts was between 3 to 1 and 4 to 1, the court stated, "Such an imbalance belies the existence of a profit motive." The court further found no evidence in the record that a "period of six years is customarily necessary to bring an aircraft leasing operation to profitable status." The court also found that Worley had not obtained expert advice on aircraft leasing despite his lack of knowledge in this area, and that he devoted most of his time to his medical practice. Finally, the court found that Dr. Worley had substantial income from his medical practice that he offset with the aircraft losses. The court also noted Dr. Worley's long-standing personal interest in aviation.

Lemler v. Commissioner of Internal Revenue, T.C. Memo 1979-308

In 1970, Drs. Lemler and Smith, both commercial pilots, formed a subchapter S corporation, Elhon, to purchase a Bellanca aircraft. Elhon entered into an agreement with Bellanca Aircraft Company whereby Elhon agreed to use its own plane to demonstrate the Bellanca at its own costs, in exchange for a 5% commission on the sale of a Bellanca to one of Elhon's prospects. In 1971, 28% of the total flight time in the Bellanca was attributable to demonstration flights. The remaining time was related to maintenance, proficiency flights, and personal use. By 1975, only 1% of total flight time was attributable to demonstration flights. Elhon was not responsible for any sales of Bellancas and earned no revenue under the agreement. In late 1972, Elhon also began operating a flight school at the Asheville, North Carolina airport. The flight school was established as part of Elhon's efforts to establish a fixed base operation at the airport. Elhon discontinued the flight school in 1975 because maintenance expenses were excessive when compared to revenue. Efforts to establish the FBO were unsuccessful. For the taxable years 1971-1975, Lemler and Smith claimed Elhon's losses on their personal tax returns. The Internal Revenue Service disallowed the losses on the ground that Elhon was not engaged in a trade or business for profit.

On appeal to the Tax Court, the IRS conceded that the flying school was a trade or business engaged in for profit. The IRS, however, maintained the Bellanca demonstrations were not a trade or business and, thus, the losses associated with this activity were not deductible. Lemler and Smith opposed bifurcating Elhon's activities and argued Elhon's overall business purpose was to establish a full-scale aviation business that included the flight school and the demonstration flights. The court rejected their argument and stated that Elhon did not have a cohesive plan for establishing such a business. The court found that minimal efforts were made to start an FBO and that there was no correlation between the demonstration flights and the flight school, especially since the Bellanca was too sophisticated an aircraft to use for flight training. Thus, the court held that the bifurcation of the activities was appropriate. In determining whether the demonstration flights constituted a business or trade, the court stated that Elhon had no prospect that the demonstration flights would be profitable. Lemler and Smith did not expect sales to exceed one or two aircraft a year, and the commissions associated with such sales would not cover the cost of the plane and operating expenses. The court noted that Lemler and Smith used the Bellanca for proficiency flying, flights to medical meetings, and pleasure trips more frequently than for demonstration flights. The court found Lemler's and Smith's reliance on the fact that Elhon maintained records of its income and expenditures misplaced, and stated these facts do not prove an expectation of profit.