Economic Stimulus Incentives Apply to 2012 New Business Aircraft Deliveries
New aircraft purchases and new equipment purchases for used aircraft are subject to a special 50% bonus depreciation allowance in 2012. In certain cases, depending on the details of the contract through which the 2012 aircraft is acquired, the bonus depreciation may be enhanced to 100% of the aircraft or component cost. 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). The new bonus depreciation excludes property acquired under written binding contract in effect prior to January 1, 2008.
50% Bonus Depreciation Available to 2013 Aircraft Under Contract in Place in 2012
Current law also extends 50% bonus depreciation to 2013 deliveries made pursuant to binding contracts entered into between January 1, 2008 and December 31, 2012. 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 2012. 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 value of the used asset.
Section 179 Expensing Also Available in 2012
In addition to the bonus depreciation allowance, an expensing election is also available to small businesses which engage in capital investments of less than $699,000 within the year. The expensing election applies to both new and used business property acquired through purchase and placed in service during 2012. The expensing allows taxpayer to write-off up to $139,000 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 capital investment for the year exceeds $560,000. The major advantage of the expensing election over bonus depreciation is it’s available 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: $600,000
179 Deduction: $99,000 (($139,000 reduced by ($600,000 –$560,000))
Bonus Depreciation: $250,500 (50% of ($600,000 – $99,000))
Ordinary Depreciation: $50,100 (20% (the normal first-year depreciation)
Total Yr. 1 Write-Off: $399,600
% of Purchase Price: 66%
Prepare for the Coming of the IRS
Although Congress and the President are encouraging 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. Proposed 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.
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.