Can a prospective aircraft owner benefit from claiming 100 percent “bonus depreciation” even though the owner expects to fly the aircraft for personal use? Yes, with limitations and careful structuring under the Internal Revenue Code (IRC). However, in doing so, it is essential to harmonize potentially conflicting rules in the IRC with the Federal Aviation Regulations (FARs) and state law, including sales/use tax laws.
The Tax Cuts and Jobs Act of 2017, which became law on December 22, for the first time allows aircraft owners temporarily to take 50 percent or 100 percent bonus depreciation deductions on preowned aircraft. It also doubles the pre-existing 50 percent bonus depreciation to 100 percent of the cost of certain new aircraft.
A business taxpayer who owns an aircraft can take 100-percent bonus depreciation deductions under the IRC against gross income if it uses the aircraft in its trade or business or for production of income. However, an owner cannot take depreciation deductions for personal use, including entertainment, amusement, or recreation.
The IRC allows certain owners to deduct depreciation from gross income by two methods. The first is straight-line depreciation created under the Alternative Depreciation System. This allows owners to take equal depreciation deductions each year of the “recovery period”—the years to fully write off aircraft. That is six years for aircraft operated under Part 91 and 12 years for aircraft operating under Part 135.
The other depreciation method is the Modified Accelerated Cost Recovery System (MACRS). MACRS allows an owner to write off its aircraft and certain helicopters in five years for Part 91 usage and seven years for Part 135 usage. An owner must qualify for MACRS to claim either 100 percent or 50 percent bonus depreciation.
IRC Section 280F prescribes that an aircraft must be “predominantly used in a qualified business use for any taxable year.” This deceptively simple idea presages complex rules about claiming depreciation deductions, including 100 percent bonus depreciation, on mixed personal and business use of aircraft.
It also contains a leasing trap: qualified business use normally does not include leasing aircraft to any 5 percent owner or related person, such as a family member. This rule could prevent an aircraft from qualifying for MACRS (and, by extension, for 100 percent bonus depreciation).
Further, the tax law introduces a new ambiguous requirement—to qualify for 100-percent bonus depreciation, “the original use” of the aircraft must begin with the taxpayer. It is unclear what this means, especially the word “use,” or how it affects new or preowned aircraft. The regulatory morass and value of tax reduction demand careful structuring and calculations to mitigate these risks.
Despite the best business planning, personal use inevitably happens. When it does, owners must calculate the “entertainment disallowance percentage” attributable to their personal use—the portion of entertainment use relative to total flight time or hours.
I often hear prospective owners worry that their personal use might unravel the benefits of 100-percent bonus depreciation, but a special regulation allows an owner to elect and calculate the disallowance in year one on a straight-line basis, spreading out depreciation over six or 12 years.
Once an owner takes 100 percent bonus depreciation, there is no depreciation expense left to deduct starting in year two. As a result, if the owner elects straight-line, the disallowed deduction will be a much smaller amount and, correspondingly, the economic benefit of 100 percent bonus depreciation to the owner should be greater. This approach enables an owner to maximize tax savings and minimize the adverse effect of personal use on bonus depreciation.
Planning for depreciation benefits alone is not enough. Even if the aircraft owner designs the structure to comply with the tax law, that is irrelevant to the FAA. As a result, owners should anticipate facing other structuring hurdles due to potential conflicts of the IRC with the FARs and other laws, particularly state sales- and use-tax laws. For example, under a very common ownership structure, the FARs might compel an owner to push operational control out of certain limited liability companies to persons permitted to operate the aircraft under the FARs.
Although taking that step might avoid conducting illegal flight operations in a “flight department company,” the structure might involve leasing the aircraft to 5 percent owners and related persons. Similarly, 5 percent members of an LLC aircraft owner might lease the aircraft to themselves or related persons to spread out sales tax over a lease term. Owners should vet any such structure as it might run afoul of owner qualifications for MACRS.
With strong interest in tax benefits afforded by the tax law, potential purchasers might join committed ones and “pull the trigger” to acquire a new or preowned aircraft. If, in any aircraft purchase, the prospective owner properly structures its transaction to claim bonus depreciation consistent with the rules in the IRC, the FARs, and state tax laws, bonus depreciation should lower the owner’s cost of capital, increase its after-tax cash flow and reduce its federal tax bill. The value proposition seems obvious, but each owner must decide whether taking bonus depreciation when purchasing an aircraft is worth its while.
The author would like to thank Julianne Christensen, managing member of AeroCPA, LLC, for her extensive assistance on this story.
David G. Mayer is a partner in the global Aviation Practice Group at Shackelford, Bowen, McKinley & Norton, LLP in Dallas, which handles worldwide private aircraft matters, including regulatory compliance, tax planning, purchases, sales, leasing and financing, risk management, insurance, aircraft operations, hangar leasing and aircraft renovations. Mayer frequently represents high-wealth individuals and other aircraft owners, flight departments, lessees, borrowers, operators, sellers, purchasers, and managers, as well as lessors and lenders. He can be contacted at [email protected], via LinkedIn or by telephone at (214) 780-1306.