Asset Protection and the Hobby Loss Rule

Placing assets in different business entities has long been an accepted asset protection strategy. Doing so segregates the potential liability from each asset from all the others.

A good example of this approach was taken by Peter Morton, co-founder of the Hard Rock Café and related businesses. He used multiple businesses to hold the various properties and a separate entity to own the Gulfstream III, a plane he used for both business and personal travel. Doing so allowed him to segregate any potential liability arising from the plane’s operation from the other income producing assets.

Some, including the IRS, argued that doing so had tax risks. In this particular case, the IRS claimed that the plane’s holding company, which showed substantial losses each year, was a “hobby” and not a for profit activity. Morton had offset income from his other business entities with the losses from the plane holding company. The IRS claimed this was impermissible and charged Morton with $9.8 million in addition taxes. Morton paid the taxes, then filed suit in the Court of Federal Claims, asserting that the IRS was wrong.

In a landmark decision, the Court of Federal Claims rejected the IRS claim that the business entities had to be viewed as separate and distinct for tax purposes and sided with Morton, holding that they were all part of his business enterprise. As such, netting the losses against the profits was proper and the hobby loss rules asserted by the IRS did not apply.

The Court held that all of the business entities were operated for one common goal and that each contributed to the maintaining and enhancing of Morton’s Hard Rock brand. The court essentially affirmed that the business structure used for liability protection purposes does not necessarily determine the interpretation of that structure for tax purposes.

If you have questions about your asset protection strategy, its implications on your tax strategy, or need to put both in place, don’t hesitate to contact us for details. Call (480) 888-7111 or submit a web request today.