The ‘Bonus’ of Bonus Depreciation

Bonus depreciation for business jets and other assets was never intended to mean more depreciation, just faster depreciation. Available in various forms for about a decade, it allows quicker write-offs for tax purposes than the five- or seven-year schedules employed by the IRS’s modified accelerated cost recovery system (MACRS). And ever since its latest incarnation, courtesy of the 2017 Tax Cuts and Jobs Act (TCJA), bonus depreciation has permitted buyers of new or used aircraft who follow the rules to write off 100 percent of the cost in the year the aircraft are placed in service in their trade or business. 

With a 100 percent deduction available immediately, you might think there wouldn’t be room for any further depreciation. Yet in a way there is, in both a good sense and a bad sense. Here’s why.

First, the good sense. To write off 100 percent of your aircraft for tax purposes, 100 percent of the usage must be for qualified business purposes. On the standard MACRS schedules, this represents a major challenge for many jet buyers. Though you can certainly employ a jet exclusively for business, it isn’t the same kind of business asset as a bulldozer or cash register: it cries out to be used for pleasure trips, vacations, and what the IRS calls “entertainment.” For many jet buyers, owning a $20 million jet for five years and never flying on it for non-business purposes can represent a test of willpower and an invitation for creative travel and tax planning. 

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But thanks to the TCJA, to write off the entire cost of the aircraft you buy, you don’t need to resist temptation for five years; bonus depreciation provides relief: your 100 percent deduction is a function of your usage only for the year when you buy the aircraft and place it in service. If you do that this year and all your flights before or on December 31 represent qualified business use, you can write off 100 percent of the purchase price on your 2021 tax return. And if you time things right, you can minimize temptation further by taking delivery of the aircraft at year-end. So, there’s the positive “bonus”: by avoiding the five- or seven-year MACRS schedule, bonus depreciation may allow you not only to write off the cost of the aircraft faster but to write off more than you otherwise would be able to, given your typical usage.

Naturally, caveats apply. Though you don’t need 100 percent business use going forward to keep the 100 percent deduction, qualified business use in each year must exceed 50 percent of usage, and you’ll need to satisfy other requirements annually as well. Further, bonus depreciation applies only to deducting, for tax purposes, the cost of acquiring (and making improvements to) the aircraft, not to tax deductions for expenses resulting from owning and operating the aircraft in future years.

Now for the negative bonus.

For many reasons, the business jet market is very tight now. Some of these reasons have to do with COVID and the economy in general, but some relate to bonus depreciation. First, the 100 percent depreciation “bonus” provided by the TCJA won’t last forever. The standard bonus depreciation allowance will decrease to 80 percent for aircraft placed in service in 2023, and the deduction will decline to zero over the following four years. 

However, many business jets will qualify for the transition rule for “long production period property” and “certain aircraft,” which still allows a 100 percent deduction for jets placed in service in 2023. But generally, buyers wanting to take advantage of the bonus need to act sooner rather than later, and that’s putting additional stress on today’s market.

Second, the desire to close by year-end with just enough time for a few business flights is causing buyers to cut corners. Stories circulate of jet shoppers eyeballing a preowned model and then immediately closing on it without doing any significant due diligence on the aircraft, not to mention conducting a thorough pre-purchase evaluation. Many sellers are simply refusing to allow a prebuy since many purchasers are willing to forgo one. 

Even when buyers are able to secure the right to do a prepurchase evaluation, they often feel pressured to cut back on the work scope. They might be worried that discrepancies would be found that couldn’t be repaired in time for a December closing (and the requisite business flights needed to show it was placed in service) or that they couldn’t find an inspection facility that has the resources to complete a thorough prebuy on the desired timetable. If it’s late enough in the year, there may be insufficient time to accomplish the prebuy even though nothing of consequence needs to be repaired. 

The net result of this situation is that buyers seeking bonus depreciation may be paying too much for an aircraft. It may have undisclosed issues that they (and not the sellers) might someday need to pay hundreds of thousands of dollars to fix—perhaps when they sell the aircraft in saner times and their buyers do a thorough prebuy.

You might think paying too much would yield a kind of second “good” bonus: by writing off 100 percent of a price that’s too high, you write off more than the aircraft is worth. But of course, you pay for that “bonus” dollar for dollar. The real bonus in such cases is getting more depreciation (more loss) than you should; when you sell the aircraft, say, five years from now, your overpayment and the cost of fixing discrepancies that should have been addressed when you bought the airplane will constitute a kind of negative bonus: a bigger loss on the asset constituting greater real depreciation.

Before setting yourself up for extra (“bonus”) depreciation of the aircraft, it’s worth considering what the value for tax purposes of that bonus depreciation will be. There’s no question that a 100 percent bonus deduction is hard to resist. By purchasing a $20 million aircraft and placing it in service in a trade or business this year, you can protect $20 million of income from taxation; at a 37 percent tax rate, that’s a $7.4 million tax bill you don’t have to pay.

But that’s just the beginning of the analysis. As an investment, an aircraft is guaranteed to depreciate if you keep it for years. Assuming normal usage and a standard 6 percent annual loss in value (for simplicity, we’ll ignore compounding)—and that you didn’t overpay for the jet in the first place—today’s $20 million aircraft would be worth $14 million in five years. If you sell it then for that amount, you’ll have to pay tax (recapture) on the difference between the sale price and your adjusted tax basis, which will be zero given that you already wrote off the whole cost of the aircraft, or $14 million. Even assuming rates don’t go up, your tax bill when you sell will be $5.18 million at a 37 percent rate. 

Thus, net of recapture, your tax savings is actually about $2 million, plus an interest-free loan from the government of $5.18 million for five years. If your investment rate of return is 5 percent per annum, this adds another $1.3 million of income—before tax. You also avoided tax on the other $6 million, but that represents an economic loss. Before the TJCA, you could have shielded some or all that income from tax by doing a like-kind exchange, but the TJCA did away with like-kind exchanges, except for real estate. Still, you may be able to shield some of the recapture income by buying another business jet and writing it off with the MACRS schedules or the vanishing remains of bonus depreciation; but unless Congress resurrects full bonus depreciation, it won’t be 100 percent.

In sum, when evaluating the “bonus” of bonus depreciation, it pays to consult your tax advisers and calculate carefully what you will gain by buying a business jet and then selling it, net of taxes, several years later.