Focus on the 2017 Tax Act and Aviation – Part I
Caution: What You Don’t Know About Bonus Depreciation Can Cost You
Now, as of August 8, 2018, the IRS has issued its proposed regulations, and FMJ thinks it is worth taking a closer look at when bonus depreciation is – and is not – available.
Bonus Depreciation – Basic Requirements
The Act described four primary requirements that have been incorporated in Section 168(k) of the Internal Revenue Code for bonus depreciation of aircraft as “qualified property” in the first year:
- The depreciable property must be a MACRS property with a recovery period of 20 years or less (most business aircraft are) and must not be “transportation property” (which are subject to other rules).
- The acquisition of the property must be the taxpayer’s first use of the property.
- The property must be placed in service after September 27, 2017, and before January 1, 2028.
- The property must be acquired by the taxpayer after September 27, 2017.
In addition, business aircraft are considered by the IRS to be “listed property”, and to take bonus depreciation the aircraft must be eligible for “modified accelerated cost recovery system” (MACRS) depreciation. MACRS depreciation generally requires that the aircraft be used predominantly in a qualified business-use for any taxable year. Aircraft are subject to special rules as to “qualified business-use”, however, and there are pitfalls for taxpayers, especially in situations when the aircraft is being leased to parties that own 5% or more of the taxpayer purchasing the aircraft.
These requirements and the new proposed regulations raise several issues that a potential aircraft buyer needs to plan for if they expect to take advantage of bonus depreciation.
Timing Restrictions Planning
The timing of the aircraft acquisition matters, both in that (1) the acquisition must be after September 27, 2017, and (2) in any tax year, the aircraft must be acquired AND placed in service by the end of the year for bonus depreciation treatment. The proposed regulations appear to give some flexibility on the purchase, requiring that the property must be acquired by the taxpayer or acquired by the taxpayer pursuant to a written binding contract entered into by the taxpayer. In practice, however, the “written binding contract” flexibility is largely illusory. In most cases, the timing of placing the aircraft in service will govern the year in which you may begin to depreciate the property.
Qualifying for Qualified Business Use
Under Section 280F, to depreciate a business aircraft under MACRS in any given tax year, the aircraft must be used at least 50% in a trade or business of the taxpayer, which is defined as “qualified business-use.” There are three categories of business-use that cannot be counted as qualified business-use, however, unless at least 25% of the taxpayer’s use falls outside of these three categories:
Planning is essential, particularly in the first year, to assure that the use of the aircraft meets both the 50% and 25% tests to be eligible for MACRS depreciation. The IRS currently views even business-use under lease to a 5% person must be excluded from qualified business-use in determining the percentage of such use. In some circumstances, with proper planning, charter use of the aircraft can also constitute qualified business-use. IRC Section 168(g)(1) also requires that the aircraft be used predominantly inside the United States.
Qualified Business-Use – Year 2 and After
Taxpayers also need to take into account whether they meet the qualified business-use tests after the first year, and there are consequences for failing to meet the requirements. In particular, if the taxpayer’s business-use drops below the 50% threshold for a given tax year, the depreciation must change to straight-line depreciation in the year of the change and the taxpayer must recapture any accelerated depreciation deductions that would have been applicable to all prior years.
Passive Loss Limitations – IRC Section 469
Taxpayers that lease their aircraft also face potential limitations on bonus depreciation due to passive loss limitations. Leasing is presumed by the IRS to be a passive activity, and the depreciation deductions are considered passive losses. Under IRC Section 469, passive losses may only be deducted to the extent that the taxpayer has similar passive gains. As a result, the bonus depreciation deductions in any year may be limited to the extent that the taxpayer has adequate passive gains. If this occurs, the deductions are not lost – and they may be carried forward. But it may significantly limit the first year deductions.
Used Aircraft and First Use
The application of bonus depreciation to used aircraft is an unprecedented benefit to aircraft buyers under US law, but there are requirements here, too. Specifically, the proposed regulations make it clear that the acquisition of the aircraft by the taxpayer must be the aircraft’s first use of that aircraft. In fact, they go further and clarify that the aircraft must never have been used by the taxpayer or a predecessor at any time prior to the acquisition and the taxpayer must never have had a depreciable interest in the aircraft, whether or not the taxpayer actually claimed depreciation. If the taxpayer arguably had such an interest in the aircraft, the taxpayer may need to decide between buying that particular aircraft and retroactively losing its depreciation in an audit situation. The proposed regulations do provide one possible exception, however, for the purchase of property at the end of an operating lease, notwithstanding the lease usage.
While 100% depreciation of aircraft can be viewed as a concession after elimination of the 1031 exchange, aircraft purchasers need to realize that the bonus depreciation begins to sunset after 2022. After that, the accelerated depreciation phases out in 20% increments until 2027, unless the benefit is extended by Congress.
The answer right now is “it depends.” It depends on the aircraft, its expected use, when you take delivery of the aircraft, when you place it into service, and your overall tax situation. It also depends on if the proposed regulations materially change. The comment period for the proposed regulations is open through October 9, 2018, and could change before they are finalized and adopted.