“Don’t play games that you don’t understand, even if you see lots of other people making money from them. ”
Bonus depreciation redux
In what is becoming an annual or semi-annual event, President Barack Obama signed a tax bill last December that extended "bonus" depreciation for purchases of new aircraft, including business jets. With each extension, the level of enthusiasm among aircraft buyers and manufacturers has dissipated to the point where new announcements are more soporific than stimulating. This latest one commands attention mostly by introducing a first-year write-off of 100 percent.
Here's how bonus depreciation works. If you purchase an aircraft for use in a trade or business, you can ordinarily deduct its cost for tax purposes in accordance with schedules published by the IRS. Most businesses can write off a business jet on a five-year schedule (which in reality runs six years) under the Modified Accelerated Cost Recovery System (MACRS). In many cases, MACRS allows buyers to write off more than half of the aircraft's adjusted basis (generally the purchase price) in the first two years (see schedule at right).
In the past, bonus depreciation, which applies only to factory-new aircraft, allowed a special deduction in the first year equal to 50 percent of the airplane's adjusted basis.
After writing off this 50 percent, you apply the normal statutory depreciation deductions, in year one and all subsequent years, against the remaining 50 percent of the adjusted basis. That's still the general rule for aircraft placed in service in 2012, but for the rest of 2011, the new legislation allows a write-off of 100 percent of the aircraft's adjusted basis. This carries the stimulus strategy about as far as it will go, at least as long as our laws limit tax deductions to actual costs.
As you can see from the table, bonus depreciation creates substantial tax deductions in the first year by accelerating the already accelerated MACRS depreciation schedule.
To qualify for 100-percent bonus depreciation, you must enter into a binding contract to purchase a factory-new aircraft after 2007 and before 2012; place the aircraft in service before the end of 2011; and satisfy certain other requirements. And-as they say in those old ads for kitchen gadgets on late-night TV-there's more! If your aircraft isn't delivered until 2012, you can still qualify for 50-percent bonus depreciation, which, as shown in the table, lets you write off 60 percent of the cost in the first year.
But wait, there's still more! Under special rules applying to aircraft not used in the business of transporting persons or property, you can also qualify for 100-percent bonus depreciation for 2012 deliveries (if you sign the contract in 2011) and 50-percent bonus depreciation for 2013 deliveries (if you sign in 2012) as long as you use the aircraft in your business and don't charter it out. Even if you fail this test, you may still be eligible for bonus depreciation on the portion of the aircraft manufactured in 2011 or 2012. Special rules also apply for aircraft that qualify as "self-constructed property."
In theory, bonus depreciation is good medicine for what ails the U.S. economy by stimulating the manufacture of assets like airplanes. But in the case of business aviation, it's hard to see how it will have much impact. It pulls the benefits of bonus depreciation forward two years, which means you can qualify even if you signed up to buy the aircraft before Congress enacted the legislation. For many aircraft buyers who signed contracts in 2010, it's just a big tax giveaway.
At least we get an extra two years of stimulus, right? Well, most heavy and long-range aircraft are sold out through 2011, so any major increase in sales this year will have to involve sales of light and medium jets. But don't hold your breath. Bonus depreciation appeals only to businesses that are making money and need to shelter income from taxes. One reason light and medium-size jets aren't selling as rapidly as larger aircraft is that many middle-market companies that might buy them apparently aren't making much money now. And as such, a big tax deduction is worthless to them. Even companies that are doing well may have net-operating-loss carryovers and credits that obviate the need for more tax write-offs in 2011 and 2012.
And then there's the impact on aircraft manufacturers. Doing good things for them by increasing sales is the whole point of bonus depreciation, which is why it's worth remembering that many business jets aren't manufactured by U.S. companies. To the extent that bonus depreciation really does stimulate new aircraft sales by U.S. companies, it may also stimulate something else: aircraft prices. It stands to reason that a manufacturer will be less willing to discount the price of an aircraft position if it becomes more desirable because it qualifies for bonus depreciation.
Further, Uncle Sam doesn't hand out bonus depreciation based on the scheduled delivery date of an aircraft; the taxpayer has to actually place the aircraft in service in a trade or business in 2011 to write off 100 percent. So if, as often happens, the manufacturing process runs a little late and you place your aircraft in service in the next calendar year, you may have overpaid for an airplane that isn't entitled to bonus depreciation at the expected level, if at all.
If saving money is the concern, consider a preowned aircraft. At this writing, few if any Challenger 605s are available that will qualify for 100-percent bonus depreciation. On the other hand, more than 40 preowned Challenger 604s are on the market. You can't write off 100 percent of the cost in 2011, but the Challengers cost a whole lot less than new aircraft. In fact, it's a shame bonus depreciation isn't available for preowned aircraft, since many companies (and aircraft lenders) have lots of cash but are reluctant to invest it to expand their business in an uncertain economy.
Finally, the benefits of bonus depreciation are less spectacular than they sound. Despite its name, bonus depreciation doesn't create new tax benefits; it only accelerates those that already exist. The "bonus" refers to the time value of money-the front-loading of deductions the buyer is already entitled to under MACRS. Bonus depreciation can still be valuable, but do your homework before you let it influence an aircraft purchase decision. Don't buy the wrong airplane just because it offers earlier tax write-offs.