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“FISCAL CLIFF” DEAL EXTENDS BONUS DEPRECIATION & RETROACTIVELY ENHANCES EXPENSING ELECTION FOR 2012 AND INTO 2013
On January 2, 2013, Congress completed passage of a bill addressing, at least in part, the so-called “fiscal cliff” of impending tax changes slated to occur at the end of 2012. President Obama is expected to quickly sign the package into law. Of particular interest to those acquiring aircraft in 2013 or 2014, the law will extend the purchasing incentive of bonus depreciation, making it broadly available in 2013, and available to certain aircraft acquired in 2014 pursuant to contracts entered into this year. Further, many who acquired aircraft, or invested in aircraft upgrades, during 2012 will benefit from the law’s retroactive increase in the amount of such investment that can be expensed in the 2012 tax year.
Under the package passed by Congress, aircraft purchases, as well as new equipment purchased and installed in used aircraft, are subject to a special 50% bonus depreciation allowance in 2013, as they were in 2012. The additional first-year depreciation deduction is allowable both for regular income tax purposes and alternative minimum tax purposes. All property qualifying for bonus depreciation must be new, used primarily for business purposes, and meet other tests necessary to qualify for modified accelerated cost recovery system depreciation (MACRS). Bonus depreciation excludes property acquired under written binding contract in effect prior to January 1, 2008.
50% Bonus Depreciation Available to 2014 Aircraft Under Contract in Place in 2013
The new law also extends 50% bonus depreciation to 2014 deliveries made pursuant to binding contracts entered into between January 1, 2008 and December 31, 2013. Such contracts must be in writing, must be binding under state law against the purchaser, and must not include any liquidated damages clause that limits damages to an amount less than 5% of the aircraft/component price. Further, if the aircraft in question is a non-commercial plane (generally, Part 91), then (1) the contract must include a non-refundable deposit greater than the lesser of 10% of the aircraft cost or $100,000, (2) the aircraft must cost more than $200,000, and (3) the aircraft must have an estimated production period exceeding 4 months. If the aircraft is commercial (i.e., used in the business of transporting persons or property for hire), it must have an estimated production period exceeding 1 year and a cost greater than $1,000,000. In the case of commercial aircraft, bonus depreciation only applies to the extent of the aircraft’s completion before the end of 2013. Note, special rules may apply to agricultural and firefighting aircraft.
Eligible Costs Include Installation Cost of New Equipment
In calculation of cost eligible for bonus depreciation, a taxpayer may include the cost of installation, inspection, certification, and the like. If refurbished equipment includes both new and used components, the entire cost is subject to bonus depreciation if less than 20% of the value is attributable to the used component.
Section 179 Expensing Election Retroactively Enhanced for 2012 and Into 2013
Prior to the new law, the tax code provided for an expensing election of up to $139,000 for small businesses in 2012, with that amount expected to fall to approximately to $25,000 in 2013. The new law, however, increases the available expensing election to $500,000 for both 2012 and 2013.
The expensing election, which is available to both new and used business property purchased and placed in service during 2012 or 2013, is in addition to the bonus depreciation allowance, and can benefit small businesses which engage in eligible investments of less than $2,500,000 within the year. The expensing allows a taxpayer to write-off up to $500,000 of equipment, but in no case more than the taxpayer’s income. Further, the available write-off decreases dollar-for-dollar to the extent that the taxpayer’s total investment in qualifying property for the year exceeds $2,000,000. The major advantage of the expensing election over bonus depreciation is its availability for used property.
Ordering of Deductions
When both bonus depreciation and Section 179 expensing are available and desired, the deductions are calculated by applying Section 179 first, followed by bonus depreciation, and last the regular depreciation allowance.
Example: New non-commercial aircraft placed in service within the first three quarters of the year by a taxpayer able to use the Section 179 deduction:
|Aircraft cost –||
|179 deduction –||
|$500,000 reduced by ($2,200,000 – $2,000,000)|
|bonus depreciation –||
|50% of ($2,200,000 – $300,000)|
|ordinary depreciation –||
|20% (normal first-yr depreciation $2,200,000 – $300,000 – $950,000|
|total year 1 write-off –||
|% of purchase price –||
Prepare for the Coming of the IRS
Although Congress has encouraged taxpayers to invest in new property purchases under these incentive provisions, taxpayers must exercise extreme care to sustain the deductions under IRS scrutiny. The Service has a number of tools at its disposal to claw back tax savings so graciously provided by the legal tax incentives. Some of the more common attacks include the following:
- The aircraft is a hobby, not a business at all – the substantial tax savings available under these incentive provisions can actually provide fodder to the arsenal of the Service in asserting the transaction was tax motivated rather than business driven.
- It’s a passive activity and therefore deductions are limited to this undertaking – common industry practice is to hold an aircraft in a special purpose entity for business and liability reasons. Income tax laws provide for grouping elections that must be meticulously complied with to avoid having the airplane activity be treated on a stand-alone basis.
- Personal entertainment use of the aircraft by owners may reduce allowable depreciation – in 2004 Congress passed legislation limiting deductions of aircraft used for personal entertainment of owners and key employees. Great care must be exercised in both the use of the aircraft and its documentation to guard against loss of depreciation deductions due to these limitations. New regulations also provide for a special depreciation election deduction solely for purposes of computing this limitation.
- Basis and at-risk limitations – aircraft are often purchased through borrowed funds, the debt repayment of which is amortized over many years. Although funds may be borrowed and repaid in future years without impacting deductibility, limitations exist related to both entity basis and “at-risk” requirements.
- Is the aircraft new, and when was it purchased – there are definitive rules outlining what is new (and special rules for fractional ownership). There are also special rules relating to contracts for purchase.
- Other MACRS limitations – there are also restrictions for qualified property impacting related party leasing, business use by shareholders, and domestic use requirements.
As is apparent from the issues outlined above, the assurance of bonus depreciation and enhanced expensing deduction analysis cannot end at the time of acquisition. Although the acquisition of a new aircraft may be an effective business tool, the tax benefits must be carefully planned, documented, and defended. Federal Aviation Regulations also impact issues relating to ownership, registration, operation, and compensation. These regulations must be integrated into aircraft tax and liability issues.
This information is general in nature and purchasers are encouraged to seek experienced legal counsel in aircraft acquisition planning and implementation.
January 2, 2013
Jonathan Levy, Esq.
Advocate Consulting Legal Group, PLLC is a law firm whose practice is limited to serving the needs of aircraft owners and operators relating to issues of income tax, sales tax, federal aviation regulations, and other related organizational and operational issues.
IRS Circular 230 Disclosure. New IRS rules impose requirements concerning any written federal tax advice from attorneys. To ensure compliance with those rules, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under federal tax laws, specifically including the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.