Qualifying Your Jet for Bonus Depreciation

Bonus depreciation is a hot topic in business aviation these days. The term is a bit misleading, because you can never get a “bonus” amount for depreciation over and beyond what you actually pay for an aircraft; the “bonus” is that you get your write-off faster.

Bonus depreciation was originally dreamed up following the 9/11 attacks as an economic stimulus strategy and has waxed and waned ever since. The so-called Tax Cuts and Jobs Act (TCJA) of 2017 introduced the latest version, which raised the bonus percentage to 100 percent coupled with the elimination of like-kind exchanges for property other than real estate. The demise of like-kind exchanges would be more palatable to the business world if 100 percent bonus depreciation was a permanent benefit, but the TCJA scheduled its phaseout starting in 2023, and by 2028 bonus depreciation will be gone entirely—unless Congress resurrects it, as it has repeatedly in the past.

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IRS Finalizes Regulations for 100 Percent Bonus Depreciation

Companies can write off the entire cost of business aircraft in the year they enter service.

Meanwhile, the opportunity to write off 100 percent of the cost of an aircraft in the year it’s acquired provides an attractive incentive to purchase a business jet. And this latest version is not limited to factory-new aircraft; it applies to preowned ones as well. Keep in mind, however, that due to the repeal of like-kind exchanges, to the extent that you are replacing an aircraft that was depreciated for tax purposes, the benefit of bonus depreciation will be partly offset by the recapture of previously taken income tax deductions on the existing aircraft.

Fans of the TCJA tout that it has simplified taxes, which in some ways is true. Like-kind exchanges involved limited time periods and complicated rules. The need to complete the sale of the relinquished aircraft within six months, though, provided a strong motivation to move the sale along. With the TCJA, on the other hand, the prospect of paying depreciation recapture taxes encourages aircraft owners to avoid buying a replacement and to squeeze the maximum value out of their existing jets. 

Reasons to Sell Now—Or to Wait

If my fully depreciated aircraft that’s currently worth $15 million will be worth $2.5 million less in two years, that’s $2.5 million of taxable income I can eliminate and $12.5 million of taxable recapture income I can postpone by keeping the aircraft two more years. Of course, the flip side is that if I buy a $50 million replacement aircraft today, with bonus depreciation I can theoretically write off the whole $50 million in 2020. So how do I do that?

Here the TCJA seems a whole lot less simple. The first and most well-known requirement is that aircraft must be “placed in service” in my trade or business this year. IRS regulations say that property is considered placed in service when it is “first placed in a condition or state of readiness and availability for a specifically assigned function.” 

A 1982 IRS private letter ruling provides a relatively needless clarification that, in the case of a business jet, this includes installing an interior so passengers can fly in it. Since the regulation says nothing about actual business use, arguably I should be able to place my newly acquired $50 million aircraft in service simply by parking it in the hangar before year-end, as long as I’ve done everything necessary to make it ready and available for business flights when needed. 

Further, it makes sense to start tax depreciation at the same time as economic depreciation begins even if there are no flights. Just taking delivery of a factory-new business jet, after all, results in a sizable loss in value without any flights required. In one case, a court allowed a taxpayer to start writing off the cost of a newly acquired barge that the owner couldn’t use by year-end because it was in a frozen canal, in part (the court said) to reflect the “gradual deterioration of the completed asset that was taking place.” Until the ice melted in March, the barge was never used.

But there was no need to prove the barge could float. On the other hand, an IRS revenue agent, presented with the opportunity to deny a $50 million tax deduction for a year in which an aircraft was never flown, may have serious doubts about its state of “readiness.” You could tell the revenue agent that you just didn’t have any business trips this year, but that sheds doubt on the business need for the aircraft and doesn’t dispel the notion that it wasn’t really flyable. Safely parked in the hangar, it may have been “available,” but how do you prove it was really in a “state of readiness”? 

Placing Your Jet in Service

Most aviation attorneys and accountants recommend that, to establish the aircraft was placed in service in the business, the buyer actually use it by taking several business flights prior to year-end. This is consistent with some IRS rulings requiring full operational use for the placed-in-service requirement. 

In one business jet case, the U.S. Tax Court said that the asset to be depreciated must “be available for its intended use on a regular, ongoing basis before we can find it ‘placed in service’ in the tax year in question.” Multiple flights would help establish that. And flying the aircraft before year-end solves another problem: it demonstrates what the percentage of business use is and thus what the primary use is. One-hundred percent business use, one hopes.

But in the case of 100 percent bonus depreciation there is a downside to taking several flights. To use the aircraft in the business, you need only one business flight, but to qualify for 100 percent bonus depreciation, all the flights must satisfy the usage requirements in the year you place the aircraft in service, so if the IRS succeeds in challenging one of the flights as not meeting those requirements, you will still be able to take depreciation, but not at the 100 percent level. Accordingly, one incontrovertible business flight might be the best option. 

As with the frozen barge, if you can’t fly the aircraft before year-end because of events beyond your control, bonus depreciation might still be available. If weather shuts down the airport at the end of the year after you take delivery of the aircraft, you may be fine. If you can’t fly because you neglect to replace a flat tire, you may not. Note that if the IRS denies you placed the aircraft in service by year end, you still have the option to place it in service the following year.

Keeping Your 100 Percent Deduction

Unfortunately, securing the 100 percent deduction isn’t the end of the story. Those same business-use requirements continue to apply in subsequent years, except going forward you need only 50 percent qualified business use instead of 100 percent—obviously an easier standard to satisfy. 

Qualified business use, as defined by the Tax Code, does not include leasing an aircraft to a 5 percent owner or related person, or personal use by such persons even if treated as compensation. However, if at least 25 percent of the use in a given year is qualified business use, these exceptions do not apply, and (for example) flights by a 5 percent owner treated as compensation can count for satisfying the 50 percent use test.

There are other requirements that you must satisfy to qualify for or keep bonus depreciation and accelerated depreciation in general. For example, if you predominately use your jet outside the U.S. in a given year, it won’t qualify. Taxpayers who write off 100 percent of the aircraft this year and then flunk the requirements in a subsequent year are stuck using the “alternative depreciation system” (ADS), which allows you to write off the aircraft on a straight-line basis, and you will have to go back to prior years and recapture and pay tax on income to the extent you deducted more than allowed by ADS. 

In short, the rules going forward are as important as the ones that apply in the year you place the aircraft in service, and you’ll need expert advice if you plan to take advantage of and keep 100 percent bonus depreciation of a business jet.