It is rare to have a discussion with a tax-motivated aircraft buyer without delving into the topic of bonus depreciation. For business owners looking to acquire an aircraft for business use, bonus depreciation is an important decision driver. In this article, we will address some common misconceptions, share some insights, and explore a few limitations about bonus depreciation.
Misconceptions
If we decide to take 100 percent bonus depreciation, does that mean we cannot have personal use this year?
Taking bonus depreciation does not require 100 percent business use in the first year of the aircraft purchase. Personal flights can be taken as long as more than 50 percent business use is maintained in the first year and in all subsequent years during the aircraft’s depreciable life. However, limiting personal flights in the first year is a good idea, as it will minimize the amount of disallowed depreciation and operating expense.
If we bonus depreciate a $1 million aircraft and fly 25 percent for personal entertainment use, will we lose $250,000 of the depreciation?
You shouldn’t. Internal Revenue Code § 1.274-10(d)(3) provides an election that allows the taxpayer to disallow against hypothetical straight-line depreciation rather than the purchase price. This election is quite favorable; we will further examine its benefits in the section below.
How much money will I actually save by bonus depreciating my aircraft?
The answer to this question depends on the combined marginal tax rate of the income that is being reduced. An often-used rule of thumb is 40 percent; thus, a $1 million aircraft purchase may yield a $400,000 tax liability reduction to the taxpayer (assuming 100 percent business use).
What’s the difference between taking 100 percent bonus depreciation this year and writing off straight line? Don’t I get the same amount of write off either way?
If the plane is used 100 percent for business, the amount of allowed expense will be the same. But when personal entertainment use is introduced, bonus depreciation becomes preferable. See the hypothetical below:
- $1 million aircraft purchase
- October 1 delivery
- 80 percent business use each year
If the taxpayer elects to utilize straight line, the total write off would be $800,000 over six years.
If the taxpayer elects to utilize bonus depreciation and the available election under §1.274-10(d)(3), the total write off would be $990,000, all taken this year.
In addition to minimizing the effects of personal use, bonus depreciation also makes it easier to manage personal use in the first year when the aircraft is acquired near the end of the calendar year. For example, if an aircraft is purchased on December 1, then the taxpayer only needs to limit personal use for one month. Over 50 percent business use will need to be maintained for the depreciable life of the aircraft, but personal use in subsequent years will not have a substantial impact on deductions, as disallowance will only be applied to annual operating expenses.
Will there be 100 percent bonus depreciation in 2022?
100 percent bonus depreciation should be available in 2022 based on current law. Bonus depreciation is scheduled to phase out in increments from 2023 to 2026. Currently, there is no discussion by Congress to eliminate bonus depreciation for 2022.
When should a taxpayer not take advantage of 100 percent bonus depreciation?
For some situations, 100 percent bonus depreciation may not be optimal. For example, a company with $1 million of taxable income may not want to bonus depreciate a $5 million aircraft and create a $4 million tax loss in 2021. Although this is allowable by the tax code, creating a significant tax loss may increase IRS audit risk.
If your taxable income consists of long-term capital gains (LTCG), the fact that LTCG are taxed at lower rates than ordinary income can impact the decision of taking bonus depreciation. When the aircraft is sold, depreciation recapture will be taxed as ordinary income.
The result is an unfavorable mismatch; lower tax rate income will be reduced in the current year, but higher tax rate income will be created by depreciation recapture upon sale of the aircraft.
There is not a “one size fits all” tax planning strategy relating to the acquisition of an aircraft. Your tax advisors should consider your immediate to long-term tax strategies and the changing tax legislation landscape when determining how bonus depreciating a business aircraft could fit into your overall tax plan.
KJ McCarter is an advisor at Aviation Tax Consultants and a licensed CPA in the state of Illinois. He is based at ATC’s headquarters in Columbus, Indiana.
