Satisfying a Tough IRS Standard

To start writing off your newly acquired jet for tax purposes in the U.S. you have to do more than buy it; you have to “place it in service” in your business. In recent years, the availability of “bonus” depreciation has only upped the ante on satisfying this Internal Revenue Service requirement.

According to conventional wisdom, to place an aircraft in service, it’s enough to fly a few business trips. That’s obviously what insurance-agent-to-the-stars Michael D. Brown thought when he bought his factory-new Bombardier Challenger 604 in 2003. Unfortunately for him, the U.S. Tax Court disagreed.

Brown decided to buy the Challenger to take advantage of bonus depreciation, which would allow him to write off 50 percent of the $22 million purchase price against his 2003 taxable income. He signed a contract on December 16 and took delivery of the airplane in Portland, Oregon, on December 30, just in time to qualify for 2003 bonus depreciation. To cram in some business flights before year-end, he flew immediately to Seattle, ostensibly for a business lunch, and later that day took the aircraft to Chicago for another quick business meeting at a Midway Airport pizza restaurant.

The Tax Court’s description of these flights and of the factual inconsistencies in Brown’s accounts and records concerning them is dripping with skepticism. Moreover, Brown didn’t do himself any favors three years later when the IRS audited him and he asked the people he’d met with to sign backdated letters he wrote recounting the business value of the meetings.

But his biggest mistake was seemingly the most innocuous. Before closing on the airplane, Brown signed a work order with Midcoast Aviation, which had completed the aircraft, to install a conference grouping and larger display screens, both of which he steadfastly maintained were needed for his business use of the aircraft. Promptly after his hectic end-of-year flights, the Challenger returned to Midcoast for the additional work.

Brown no doubt emphasized that his business necessitated the post-closing installations because he wanted to make sure that the $500,000 cost of the improvements would be tax-deductible. In doing so, he shot himself in the foot, for the Tax Court concluded that, if the installations really were necessary, then the aircraft wasn’t ready to be placed in service for Brown’s business use in 2003, and he wasn’t entitled to commence depreciation for tax purposes that year.

According to Brown’s own testimony, the court observed, “his insurance business required that the airplane have a conference table and the larger screens so he could make his PowerPoint presentations to clients and other agents—and those presentations were not a peripheral part of his business.” Even though he had arguably used the aircraft in business in 2003, he failed to place it in service that year because, until the modifications were completed, the aircraft was not “ready and available for full operation on a regular basis for its specifically assigned function” and thus “wasn’t sufficient to meet his specific business needs.”

The Tax Court was clearly determined to hang Brown, who reportedly settled with the IRS for $20 million in back taxes and penalties. But the case also sheds light on what it takes to start the IRS depreciation clock ticking on an aircraft by “placing it in service.” In the 1966 Sears Oil case, a barge was delivered to the taxpayer before year-end, but the taxpayer couldn’t make business use of it until the following year because it was frozen fast in an icy canal. The court allowed tax depreciation to commence in the year of delivery, noting that deterioration of the barge had already begun and that the taxpayer was prevented from using the boat by circumstances beyond its control.

Citing Sears Oil, the Brown court concluded that “it’s possible for a taxpayer to place an asset in service for a certain tax year even without using it that year.” However, to be considered as “placed in service” in a given year, the court said, the aircraft must be “available for its intended use on a regular, ongoing basis” that year, though circumstances beyond your control may prevent you from using it.

Does this mean you can dispense with those business flights that aviation lawyers make their clients take every December after their aircraft are delivered? Hardly. Unless your aircraft is frozen in a canal or the like, it’s still important to fly it for business purposes in the year you take delivery. But don’t send an administrative assistant from the New York office to deliver a package to the Philadelphia office on December 31 in your brand-new Gulfstream G650 and call that your business trip. On the contrary, the business flights should be genuine, involve company personnel that would be typical passengers, and be the kind of trips you would use the aircraft for. And the more flights the better. Brown also illustrates the importance of accurate and contemporaneous documents and records regarding the business flights.

The key message of the case, though, is that the IRS will be looking to see whether the aircraft is capable of fulfilling your specific business functions. Suppose, for example, that the main reason to purchase a business jet is to ensure that the CEO is in touch with the company at all times while traveling. You will be hard-pressed to show that that business function was met in the year of delivery if telephones and Wi-Fi weren’t installed until the following year.

Finally, be realistic about the value of taking depreciation on an aircraft, the benefit of which is simply the time value of money. The advantages of bonus depreciation, for example, are often overestimated, especially if an aircraft’s availability for super-accelerated tax write-offs drives up the price. Brown was so desperate to get bonus depreciation in 2003 that he bought a jet with the wrong interior in December only to put the aircraft down a few days later for a $500,000 retrofit in January. The opportunity cost on $22 million probably added at least another $100,000 expense. Tax benefits are important, but it’s worth considering all relevant factors before allowing them to determine your aircraft purchase. 

Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.