Does My Aircraft Qualify for 100% Bonus Depreciation?
In the past some clients have asked in a joking tone, "Can't I just write off the new jet this year and call it good?" and the answer has always been "No". Then the Tax Cuts and Jobs Act of 2017, "The Tax Bill", passed in December 2017 and the answer is now "Maybe". The Tax Bill added a provision for 100% bonus depreciation on Qualified Assets, both new and used, placed into service after September 27, 2017 and before January 1, 2023 when a phaseout begins.
Now clients are asking, "If I buy a new aircraft does it qualify for 100% bonus depreciation?" and the answer is not always black and white. I find myself asking three questions right off the bat... The first question is whether or not the airplane operations qualify to take bonus? The second question is whether or not the personal use and/or personal passengers on the flights will affect the ability to deduct 100% of that bonus depreciation, or will it be limited? The third question that I am asking is about the future operations to see if there is a strong possibility that the depreciation will be recaptured in the future due to decreased business use. There are many other follow up questions, but for the purpose of this post, let's just explore these three.
Disclaimer: This post attempts to simplify the law as much as possible, but does not cover all exceptions to the general rules. Each situation should be evaluated separately and if you have specific questions, contact your advisor.
Question #1: Is the aircraft a qualified asset for bonus depreciation?
To qualify for bonus the asset must be eligible for MACRS depreciation. One of the requirements is that the asset is not used predominately outside the United States. Therefore, additional due diligence is needed for aircraft operations with a large international component. Another requirement for Qualified Assets is the IRC 280F 50% Qualified Business Use Test. Qualified business use means any use in the taxpayer business except for the few exceptions put in IRC 280F(d)(6)(c) which includes leases or compensatory flights to a 5% owner and related parties. IRC 280F(d)(6)(c)(ii) has a special rule for aircraft that states, if at least 25% of your flight activity is for the core business operations/qualified business use then you are allowed to include compensatory flights (such as those included in the annual SIFL calculation) and other flights for leasing to a 5% owner and related parties that normally would have been excluded under IRC 280F(d)(6)(c)(i) in calculating the 50% test.
If you fail the 25% test or if you pass the 25% test but cannot meet the overall 50% test, then you do not qualify for bonus depreciation or accelerated depreciation under MACRS and you will need to use straight line depreciation over the longer Alternative Depreciation Systems (ADS) life. If you pass both tests, then you generally qualify for MACRS accelerated depreciation and can take bonus.
It is also important to note that for purchases after September 27, 2017 100% bonus depreciation is available for new and used equipment. In the past, bonus depreciation was only available for new equipment. The Tax Bill opened this up to used equipment as long as it was the first use by the taxpayer. I will be watching for guidance to clarify what the drafters meant by this language. I anticipate that regulations will be necessary to clarify situations such as prior leasing of the equipment and assets contributed into an entity that is considered a separate taxpayer under the Internal Revenue Code.
Question #2: To what extent will your personal entertainment flights and passengers affect your ability to deduct a portion of the 100% bonus depreciation? And what can we do to reduce the impact of these entertainment passengers?
In the year of acquisition is it is important to keep an eye on personal entertainment passengers, including spouses. Under IRC 274 these entertainment passengers affect the amount of deductible aircraft expenses for the business, including bonus depreciation. Luckily, the regulations for 274(e)(2) and (9) permit a taxpayer to elect to compute depreciation expenses on a straight-line basis for all of the taxpayer’s aircraft and all taxable years for purposes of calculating expenses subject to disallowance, even if the taxpayer uses another method to compute depreciation for other purposes.
If elected, you will need to use this method for all aircraft in the fleet both owned and leased. The regulations provide a transition rule for applying the straight-line election to aircraft placed in service in taxable years preceding the election, which requires the taxpayer to apply the straight-line method as if it had been applied from the year the aircraft was placed in service. The straight line election is easily made when filing your tax return, but it is important to be aware that according to Regulation 1.274-10(d)(3)(iii), "a taxpayer may revoke an election only for compelling circumstances upon consent of the Commissioner by private letter ruling."
Using straight line for the calculation will significantly reduce the amount of the 100% bonus depreciation that is disallowed as an income tax deduction under the IRC 274 calculations. It has also been clarified in Regulation 1.274-10(d)(3)(i) that in year two after the bonus depreciation has been taken, the disallowed depreciation calculated on a straight line basis cannot exceed the amount of depreciation actually taken on the return, which will be $0 if 100% bonus depreciation is taken in year 1.
Let's take a look at two different scenarios:
On September 28, 2017, in both scenarios, the taxpayer buys a jet for $20M and places it into service in 2017. The aircraft meets all the tests for a Qualified Asset and is eligible for bonus depreciation.
Scenario 1: The taxpayer has an internal aircraft use policy in their company that does not allow any personal passengers on board the aircraft. In this hypothetical example, the client sticks to this policy and at the end of the year their aircraft expenses are 100% deductible. This includes the full $20M in bonus depreciation. Basis in the asset when sold in the future will be $0.
Scenario 2: The taxpayer often travels with personal guests and his spouse on company trips. For the purpose of this comparison, the calculated percentage that is disallowed for the spouse and other personal entertainment passengers during the year is 35% and the ADS life of the asset according to IRS Revenue Procedure 87-56 Asset Class 00.21 is 6 years for a private business aircraft not used predominantly in a commercial aviation business (aircraft used predominately in commercial and contract carrying of passenger and freight have an ADS life of 12 according to Rev Proc 87-56 Asset Class 45.0). The taxpayer would not want to reduce the bonus depreciation by 35%, losing $7M in immediate tax deductions; so the taxpayer elects to calculate the disallowance using straight line. Therefore, ADS half year convention is used and $583,333 of the depreciation is disallowed. The effective rate of bonus depreciation in year 1 for this taxpayer is not 100% due to personal entertainment passengers. The taxpayer is allowed to deduct only 65% of the other aircraft expenses as well as $19,416,667 of the bonus depreciation. The $583,333 in depreciation that was disallowed will be suspended and included as basis when sold.
The difference in the simplified scenarios above attempt to demonstrate that it is important, especially in the year of acquisition, to understand the impact that your personal travel can have on bonus depreciation and your ability to deduct your aircraft costs and it is also import to know that too much personal travel and not enough core business travel can trigger depreciation recapture, which leads us to question #3...
Question #3: What is the possibility of recapture due to decreased business use in the future?