aircraft bonus depreciation

  • Tracey Cheek posted an article
    AINsight: Maximize Aircraft Bonus Depreciation in 2019 see more

    NAFA member, David G. Mayer, Partner with Shackelford, Bowen, McKinley & Norton, LLP, discusses several aspects of aircraft depreciation including ways to qualify for bonus depreciation.

    Although the total depreciation taken under the straight-line and MACRS depreciation methods is the same, acceleration of depreciation under MACRS increases the time value of the tax benefits of MACRS compared to the slower straight-line method. Consequently, a tax advisor can help evaluate system and method that maximizes depreciation arising out of a taxpayer’s unique circumstances.

    Taxpayers must comply with the MACRS requirements for an aircraft to be eligible for bonus depreciation. Under the Tax Cuts and Jobs Act of 2017, bonus depreciation applies to new and, for the first time, preowned aircraft acquired and placed into service after Sept. 27, 2017, and before Jan. 1, 2023, with a phasedown of 100 percent depreciation starting in 2027. Importantly, to depreciate a preowned aircraft, the taxpayer must not have used the aircraft before purchasing it.

    QUALIFIED BUSINESS USE

    The IRC establishes qualifications for, and limitations on, deducting depreciation under MACRS and, by extension, bonus depreciation. MACRS requires that an aircraft must be used in a trade or business or for the production of income. A taxpayer must also “predominantly” operate the aircraft for “qualified business use” (QBU). In other words, QBU generally means the aircraft operates in connection with the taxpayer’s business enterprise conducted regularly and continuously for income or profit. Predominant use generally refers to 50 percent or more of total aircraft use per tax year.

    In part to guard against taxpayer abuse of depreciation deductions, the IRC has placed aircraft in a special category called “listed property” under IRC Section 280F. In general, listed property that a taxpayer does not use more than 50 percent for business will not qualify for MACRS or bonus depreciation. Instead, such property must be depreciated under the slower ADS using the straight-line method. In relation to depreciation, the failure to comply with MACRS may arise out of excessive personal use under the listed property rules and MACRSrequirements discussed above.

    However, in certain circumstances, an aircraft may be eligible for bonus depreciation if the taxpayer can demonstrate 25 percent business use. Once the 25 percent threshold is met, this special rule in IRC section 280F allows a taxpayer to add in other activity that the rule initially excludes from the QBU test. The effect of the add back is to boost the business use above the basic 50 percent requirement. It is important to prepare contemporaneous and detailed records that support all aspects of QBU on the assumption that the IRS will ask for the records.

    IRC Section 274 describes various types of personal use of aircraft. Often, personal use refers to the use of the aircraft for entertainment, amusement, or recreation such as parties, golf outings, family vacations, and sporting events. But it can also mean personal use of an aircraft for another reason: non-entertainment such as travel of an aircraft passenger for business unrelated to the business activities of the taxpaying entity that owns the aircraft.

    If an aircraft is used for entertainment use, the IRC has a special provision that minimizes the impact of personal use on bonus depreciation. For purposes of depreciation, the provision allows a taxpayer to elect the straight-line calculation of the disallowed deductions attributable to entertainment use. The provision permits a taxpayer to claim bonus depreciation in the acquisition year and, concurrently, elect separately to calculate an IRC Section 274 “entertainment disallowance” using the straight-line method.

    This election allows the taxpayer to deduct more depreciation in the year of acquisition than it otherwise would without the special IRC section 274 rule. This area deserves planning attention as it might, if structured correctly, provide a taxpayer with an increase in after-tax value and spur the taxpayer to establish an entertainment travel policy that applies this provision.

    COMPLIANCE: RECAPTURE INCOME

    My clients often ask whether they can claim bonus depreciation in the acquisition year by satisfying the QBU and other MACRS eligibility requirements in that year and keep bonus depreciation if they do not satisfy the QBU and other MACRS eligibility requirements after the acquisition year. In this scenario, the answer is no. And the consequence might be very expensive for the taxpayer because the Internal Revenue Service (IRS) can use a “recapture” provision.

    By doing so, the IRS causes the taxpayer to recognize income for the excess depreciation taken over the allowable straight-line method as calculated through the year of recapture. After that, the aircraft remains on straight-line and cannot return to MACRS. At a minimum, the taxpayer should track and record the QBU and other MACRS eligibility requirements throughout the ADS recovery period and, to be on the safe side, as long as the taxpayer owns the aircraft.

    Once a taxpayer qualifies for MACRS and bonus depreciation, the taxpayer will still encounter such other limitations as the passive activity loss limitations, the excess business loss limitations, and the hobby-loss rules.

    Prospective purchasers of aircraft seem universally interested in 100 percent bonus depreciation, but, as a taxpayer, the purchaser should not assume either that the aircraft will be eligible for bonus depreciation or that bonus depreciation will offer the optimal tax and economic solution. Still, by planning ahead of a purchase and involving specialized aircraft tax advisors, a purchaser should be able to identify the appropriate type of depreciation to maximize the reduction in its taxable income and lower its after-tax cost of capital. It certainly seems worth looking closely at bonus depreciation as it is easy to appreciate the significant value it might provide in an overall tax strategy.

    If you plan to purchase a private aircraft in the U.S. this year, developing and executing an appropriate tax strategy before you enter into a letter of intent or contract to purchase the aircraft enhances the likelihood that you will be able to take 100 percent depreciation (bonus depreciation). This strategy should incorporate your projected business revenues, intended aircraft use, and unique attributes as a business taxpayer relative to taking depreciation deductions.

    Depreciation is an allowance Congress enacted to encourage businesses to purchase capital equipment and other tangible personal property such as private aircraft. Depreciation allows business taxpayers to claim an annual tax deduction to recover the aircraft cost or other basis (adjusted cost) of the property for its wear and tear, deterioration, or obsolescence. A taxpayer usually deducts depreciation over a certain number of years called the “recovery period.”

    STRAIGHT-LINE, MACRS, AND BONUS DEPRECIATION

    Perhaps the best-known depreciation method is straight-line under the Alternative Depreciation System (ADS). This method allows the taxpayer to deduct roughly equal parts of the aircraft cost or other basis over the applicable recovery period. The recovery period depends on the predominant use of the aircraft. As a rule of thumb, the recovery period is six years for FAR Part 91 aircraft (private use) and 12 years for FAR Part 135 aircraft (commercial use such as chartering or carrying freight).

    The Modified Accelerated Cost Recovery System (MACRS) is another way to depreciate aircraft. The Internal Revenue Code (IRC) sets forth specific requirements that a taxpayer must meet to qualify to use this accelerated depreciation method. MACRS allows a taxpayer to write-off its aircraft in five years for FAR Part 91 (private use) aircraft and seven years for FAR Part 135 aircraft (commercial use). A taxpayer takes depreciation in the early years of the recovery period relative to approximately equal parts under the straight-line method.

    This article was originally published by David G. Mayer in AINonline on March 8, 2019.

     

  • Tracey Cheek posted an article
    AINsight: Maximize Aircraft Bonus Depreciation in 2019 see more

    NAFA member, David G. Mayer, partner with Shackelford, Bowen, McKinley & Norton, discusses how bonus depreciation has its appeal, but it might not be best for a taxpayer's particular set of circumstances.

    If you plan to purchase a private aircraft in the U.S. this year, developing and executing an appropriate tax strategy before you enter into a letter of intent or contract to purchase the aircraft enhances the likelihood that you will be able to take 100 percent depreciation (bonus depreciation). This strategy should incorporate your projected business revenues, intended aircraft use, and unique attributes as a business taxpayer relative to taking depreciation deductions.

    Depreciation is an allowance Congress enacted to encourage businesses to purchase capital equipment and other tangible personal property such as private aircraft. Depreciation allows business taxpayers to claim an annual tax deduction to recover the aircraft cost or other basis (adjusted cost) of the property for its wear and tear, deterioration, or obsolescence. A taxpayer usually deducts depreciation over a certain number of years called the “recovery period.”

    STRAIGHT-LINE, MACRS, AND BONUS DEPRECIATION

    Perhaps the best-known depreciation method is straight-line under the Alternative Depreciation System (ADS). This method allows the taxpayer to deduct roughly equal parts of the aircraft cost or other basis over the applicable recovery period. The recovery period depends on the predominant use of the aircraft. As a rule of thumb, the recovery period is six years for FAR Part 91 aircraft (private use) and 12 years for FAR Part 135 aircraft (commercial use such as chartering or carrying freight).

    The Modified Accelerated Cost Recovery System (MACRS) is another way to depreciate aircraft. The Internal Revenue Code (IRC) sets forth specific requirements that a taxpayer must meet to qualify to use this accelerated depreciation method. MACRS allows a taxpayer to write-off its aircraft in five years for FAR Part 91 (private use) aircraft and seven years for FAR Part 135 aircraft (commercial use). A taxpayer takes depreciation in the early years of the recovery period relative to approximately equal parts under the straight-line method.

    Although the total depreciation taken under the straight-line and MACRS depreciation methods is the same, acceleration of depreciation under MACRS increases the time value of the tax benefits of MACRS compared to the slower straight-line method. Consequently, a tax advisor can help evaluate system and method that maximizes depreciation arising out of a taxpayer’s unique circumstances.

    Taxpayers must comply with the MACRS requirements for an aircraft to be eligible for bonus depreciation. Under the Tax Cuts and Jobs Act of 2017, bonus depreciation applies to new and, for the first time, preowned aircraft acquired and placed into service after Sept. 27, 2017, and before Jan. 1, 2023, with a phasedown of 100 percent depreciation starting in 2027. Importantly, to depreciate a preowned aircraft, the taxpayer must not have used the aircraft before purchasing it.

    QUALIFIED BUSINESS USE

    The IRC establishes qualifications for, and limitations on, deducting depreciation under MACRS and, by extension, bonus depreciation. MACRS requires that an aircraft must be used in a trade or business or for the production of income. A taxpayer must also “predominantly” operate the aircraft for “qualified business use” (QBU). In other words, QBU generally means the aircraft operates in connection with the taxpayer’s business enterprise conducted regularly and continuously for income or profit. Predominant use generally refers to 50 percent or more of total aircraft use per tax year.

    In part to guard against taxpayer abuse of depreciation deductions, the IRC has placed aircraft in a special category called “listed property” under IRC Section 280F. In general, listed property that a taxpayer does not use more than 50 percent for business will not qualify for MACRS or bonus depreciation. Instead, such property must be depreciated under the slower ADS using the straight-line method. In relation to depreciation, the failure to comply with MACRS may arise out of excessive personal use under the listed property rules and MACRS requirements discussed above.

    However, in certain circumstances, an aircraft may be eligible for bonus depreciation if the taxpayer can demonstrate 25 percent business use. Once the 25 percent threshold is met, this special rule in IRC section 280F allows a taxpayer to add in other activity that the rule initially excludes from the QBU test. The effect of the add back is to boost the business use above the basic 50 percent requirement. It is important to prepare contemporaneous and detailed records that support all aspects of QBU on the assumption that the IRS will ask for the records.

    IRC Section 274 describes various types of personal use of aircraft. Often, personal use refers to the use of the aircraft for entertainment, amusement, or recreation such as parties, golf outings, family vacations, and sporting events. But it can also mean personal use of an aircraft for another reason: non-entertainment such as travel of an aircraft passenger for business unrelated to the business activities of the taxpaying entity that owns the aircraft.

    If an aircraft is used for entertainment use, the IRC has a special provision that minimizes the impact of personal use on bonus depreciation. For purposes of depreciation, the provision allows a taxpayer to elect the straight-line calculation of the disallowed deductions attributable to entertainment use. The provision permits a taxpayer to claim bonus depreciation in the acquisition year and, concurrently, elect separately to calculate an IRC Section 274 “entertainment disallowance” using the straight-line method.

    This election allows the taxpayer to deduct more depreciation in the year of acquisition than it otherwise would without the special IRC section 274 rule. This area deserves planning attention as it might, if structured correctly, provide a taxpayer with an increase in after-tax value and spur the taxpayer to establish an entertainment travel policy that applies this provision.

    COMPLIANCE: RECAPTURE INCOME

    My clients often ask whether they can claim bonus depreciation in the acquisition year by satisfying the QBU and other MACRS eligibility requirements in that year and keep bonus depreciation if they do not satisfy the QBU and other MACRS eligibility requirements after the acquisition year. In this scenario, the answer is no. And the consequence might be very expensive for the taxpayer because the Internal Revenue Service (IRS) can use a “recapture” provision.

    By doing so, the IRS causes the taxpayer to recognize income for the excess depreciation taken over the allowable straight-line method as calculated through the year of recapture. After that, the aircraft remains on straight-line and cannot return to MACRS. At a minimum, the taxpayer should track and record the QBU and other MACRS eligibility requirements throughout the ADS recovery period and, to be on the safe side, as long as the taxpayer owns the aircraft.

    Once a taxpayer qualifies for MACRS and bonus depreciation, the taxpayer will still encounter such other limitations as the passive activity loss limitations, the excess business loss limitations, and the hobby-loss rules.

    Prospective purchasers of aircraft seem universally interested in 100 percent bonus depreciation, but, as a taxpayer, the purchaser should not assume either that the aircraft will be eligible for bonus depreciation or that bonus depreciation will offer the optimal tax and economic solution. Still, by planning ahead of a purchase and involving specialized aircraft tax advisors, a purchaser should be able to identify the appropriate type of depreciation to maximize the reduction in its taxable income and lower its after-tax cost of capital. It certainly seems worth looking closely at bonus depreciation as it is easy to appreciate the significant value it might provide in an overall tax strategy.

    This article was originally published by Shackelford, Bowen, McKinley & Norton on AINonline on March 8, 2019.

     

  • Tracey Cheek posted an article
    What you should know about using 100% bonus depreciation for private aircraft. see more

    NAFA member, David G. Mayer, partner with Shackelford, Bowen, McKinley & Norton, LLP, discusses what you should know about using 100% bonus depreciation for private aircraft.

    Deducting the price tag of a private aircraft under the new 100 percent bonus depreciation rules is an intriguing idea, but it takes some effort. Planned correctly, a prospective aircraft owner can pocket a meaningful amount of cash related to purchasing almost any size and model of aircraft, whether new or pre-owned, including a fractional share of an aircraft.

    Knowing About the Source of the Depreciation Benefit

    The 100 percent bonus depreciation benefit arises under the Tax Cuts and Jobs Act of 2017, H.R. 1, enacted on Dec. 22, 2017, (the Act), and is now integrated into the Internal Revenue Code (IRC). The Act temporarily allows 100 percent bonus depreciation starting Sept. 27, 2017, and ending Dec. 31, 2022. Bonus depreciation will then phase down 20 percent per year for five years to a zero bonus. The IRS issued proposed regulations for 100 percent bonus depreciation on Aug. 8, 2018. When final, the regulations should help provide some clarity around certain ambiguous provisions in the Act.

    Understanding Depreciation for Business Aircraft

    Depreciation is an allowance Congress enacted to encourage businesses to purchase tangible personal property, including private aircraft. Depreciation allowances provide that business taxpayers may claim an annual tax deduction to recover the cost or other tax “basis” (adjusted cost) of the property for its wear and tear, deterioration or obsolescence.

    Aircraft owners can depreciate an aircraft’s cost or other basis by using the straight-line depreciation method under the Alternative Depreciation System (ADS) or by using the Modified Accelerated Cost Recovery System (MACRS). MACRS is used to recover the cost or other basis of most business and investment property and recovers the cost of eligible property faster than under the straight-line method.

    Straight-line depreciation divides up the aircraft cost or other basis in equal parts each year during the prescribed write-off period (called the “recovery period”) of the aircraft until the aircraft has been fully depreciated. The primary use of the aircraft determines the applicable recovery period.

    For an aircraft used only by the owner privately, the recovery period is six years under the ADS compared to five years for aircraft and certain helicopters under MACRS. For commercial use aircraft, including aircraft used to fly charters, the recovery period is 12 years under the ADS compared to seven years under MACRS.

    An aircraft that qualifies for MACRS should be eligible for 100 percent bonus depreciation in the year in which the taxpayer places the aircraft in service. Even if the aircraft is eligible for 100 percent bonus depreciation, the aircraft owner can still elect straight-line depreciation under the ADS, regular accelerated MACRS according to a schedule prescribed by the IRC (excluding the “bonus”), and 50 percent bonus depreciation – but only for aircraft acquired before Sept. 28, 2017, and placed in service before Jan. 1, 2018. The increase to 100 percent bonus depreciation applies to property placed in service after Sept. 27, 2017.

    Qualifying for Bonus Depreciation

    The IRC imposes certain requirements on private aircraft use to qualify for MACRS and, by extension, 100 percent bonus depreciation. The IRC includes private aircraft in a special category called “listed property” along with certain other property, like vehicles and computers, that an owner can use personally and for business. To qualify for 100 percent bonus depreciation, the owner must “predominantly” operate the aircraft in “qualified business use.”

    Predominant use is a critical element that refers to using the aircraft 50 percent or more of flight time. Qualified business use, in general, refers to the aircraft owner (an entity or individual) flying its aircraft in a “trade or business.” Also a critical aspect of tax planning, “trade or business” generally refers to a business enterprise conducted regularly and continuously for income or profit – such as operating a manufacturing plant. The IRC establishes a complicated calculation to achieve the status of qualified business use, which merits careful analysis.

    Among other requirements, the aircraft owner must not use the aircraft predominately outside the U.S. – an important restriction for large cabin aircraft that travel globally. Also, the owner must not have used the aircraft before acquiring it or acquire the aircraft from a related party, such as a family member.

    Illustrating the Use and Loss of Eligibility for Bonus Depreciation

    To illustrate one type of situation, consider that, in 2018 “Fast Food Co.” makes $5 million of ordinary income, which is reported on Form 1120S, an S-Corporation tax return. Fast Food Co. buys a $2 million aircraft in December 2018 to travel between multiple cities. Assuming the aircraft is eligible for 100 percent bonus depreciation, Fast Food Co. issues a federal tax Form K-1 to the sole owner/stockholder, who may then deduct $2 million on his tax return in 2019 for the 2018 tax year.

    At a 37 percent tax rate (the highest individual tax rate under the Act), the owner can effectively reduce such taxable income by up to $2 million to a net taxable income of $3 million (not considering other tax deductions or taxes). The tax savings is approximately $740,000 cash in the owner’s pocket, thanks to 100 percent bonus depreciation ($2 million x 37 percent tax rate).

    If the aircraft loses its eligibility for MACRS depreciation anytime during the aircraft ownership period, the IRS can apply “recapture” rules to add back to owner’s ordinary income an amount equal to the “excess depreciation” over straight-line depreciation. The add-back would occur in the year in which the aircraft use fails to qualify for MACRS.

    At a 37 percent tax rate, the payback to the IRS on the $2 million write-off could be significant for the owner. The tax on the excess depreciation amounts to the difference between 100 percent depreciation of the cost or other basis taken in the first year and the much smaller write-off of approximately equal amounts over the aircraft recovery period between six years for private use and 12 years for commercial use (e.g., $2 million/six years = $333,333/year instead of $2 million in year one).

    Using Aircraft for Entertainment and Other Personal Use

    Despite planning for qualified business use, most aircraft fly for personal use reasons (e.g., entertainment, amusement or recreation). Owners cannot take depreciation deductions for the flight hours or miles devoted to such personal use, but some depreciation write-offs should remain available if the aircraft is still used predominantly for qualified business use. Aircraft owners must calculate the percentage of personal use relative to business use by noting the names of each person on board, the reason for the travel, the hours and miles of travel and other information.

    These calculations determine the entertainment “disallowance” – a part of the cost or other basis of the aircraft that the owner cannot depreciate. Importantly, aircraft owners should be aware of a special rule in the IRC that minimizes the negative effect of the entertainment disallowance for owners who claim 100 percent bonus depreciation.

    Planning for Use of 100 Percent Bonus Depreciation

    Because each aircraft owner is likely to have a complex tax situation, each owner should engage knowledgeable tax advisors, typically an aviation tax accountant and lawyer, to propose the optimal tax plan. The advisors should analyze such factors as the taxpayer’s organizational structures (individual, S Corp, LLC or C Corp), types of qualified business use, tax rates and any net operating losses (NOLs), timing and types of income, potential for excess business losses affecting single and married taxpayers (new under the Act) and anticipated personal use of the aircraft. Ultimately, an owner’s best path may be to bypass MACRS or 100 percent bonus depreciation if the straight-line depreciation method produces a better tax result.

    Further, each aircraft owner should (1) keep detailed flight and passenger records, (2) develop flight planning that conforms to the tax strategy involving the aircraft, and (3) plan for IRS challenges to flying fewer qualified business use hours than necessary to demonstrate predominant business use.

    Claiming 100 Percent Bonus Depreciation in 2018

    There is still enough time in 2018 to buy and place in service an aircraft or fractional share and take advantage of the 100 percent bonus depreciation. Bonus depreciation is especially valuable toward the end of the year because it’s not long thereafter until a taxpayer can file a federal income tax return and reduce its income by an amount up to the aircraft cost or other basis. However, with 100 percent bonus depreciation available until 2023, it is strongly advisable to choose an aircraft wisely rather than rush to buy the wrong aircraft just so a taxpayer can take the tax deduction in 2018.

    Bonus depreciation has generated wide interest in purchasing new or pre-owned private aircraft and fractional shares. Although these purchases take time and planning to close, prospective aircraft owners understand that there is no time like the present to help boost the economy and take flight in a fully depreciated aircraft.

    This article was originally posted in Money, Inc. Magazine on October 29, 2018.