How Bonus Depreciation Affects Business Jet Sales

Last November, I received a call from a guy who was about to receive a massive amount of taxable income. He wanted to buy a business jet because he’d heard that he could write off 100 percent of the purchase price for tax purposes in 2018, thereby shielding tens of millions of dollars from income tax. It was a strange conversation because he had no intention of using the aircraft himself or in any business he owned; his idea was to lease it to a company that could employ it. 

I tried to explain to my caller the many things wrong with this plan. Perhaps the biggest problem was that writing off the full amount under the 2017 “tax reform” act would require him to finalize not only the purchase but the lease by year-end. 

A little background. For book purposes, accountants typically reflect the cost of buying an aircraft by expensing it over something resembling its useful life. This can be a controversial subject at any company, but at least the basic idea makes sense. The Internal Revenue Code traditionally followed similar, if rather abbreviated, schedules, allowing you to write off aircraft over seven or 12 years on a straight-line basis or, if you qualify for an accelerated (MACRS) schedule, over six or eight years, in each case depending on the airplane’s primary usage.

After the 9/11 terrorist attacks affected the U.S. economy, however, Congress passed a law allowing faster write-offs (more than 30 percent in the year acquired) for certain assets (including factory-new business aircraft) that were acquired and placed in service after Sept. 10, 2001. The concept was simple: if you can write off new assets faster than preowned ones, you stimulate the purchase and production of new assets, which arguably means more jobs and more corporate income. 

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The faster write-off was aptly titled “bonus depreciation.” Congress intended it as temporary tax relief and scheduled it to expire on Sept. 11, 2014. However, like a habit you can’t kick, it proved so popular that Congress kept extending it and increasing the percentage deductible in the year acquired—all the way up to 100 percent. 

Another extension of bonus depreciation was in the cards for “tax reform” in 2017, but the plan hit a roadblock. Tax reform was also supposed to make the more than 5,500-page Internal Revenue Code simpler, so Congress decided to get rid of complicated tax-free (or like-kind) exchanges. (One exception: the legislators opted to keep these exchanges for real estate; apparently, they didn’t want to make things too simple.) This caused considerable bellyaching in various industries because it meant business assets would be subject to the recapture of taxes when sold without the corresponding protection of the tax-free exchange rules. 

To illustrate, suppose you purchase an aircraft for $20 million and depreciate it to zero for tax purposes. You then sell it for $12 million and replace it with a $30 million preowned aircraft. Under the old law, instead of paying taxes on $12 million of recaptured income, if you structured the replacement as a like-kind exchange, the $12 million gain would simply be deducted from your $30 million basis for depreciation in the replacement aircraft, and no tax would be due. But under the new tax act, a like-kind exchange would no longer be available. 

So, to end the complaining, Congress decided to extend bonus depreciation to preowned assets. Under the 100 percent bonus depreciation rules of the 2017 tax act, it is possible to deduct the entire $30 million cost of the replacement aircraft in the year you acquire it, without having to comply with any cumbersome like-kind-exchange regulations. The $30 million deduction more than offsets the $12 million in recaptured taxable gain, so you’re basically in the same position—better actually, since you can write off the whole $30 million immediately. 

The impact of this change on business aviation has been significant. As noted above, bonus depreciation was originally designed to help the manufacturers, but making the same 100 percent write-off available for preowned aircraft left the manufacturers in the dust. After years of plummeting values, the market for preowned business jets has never been stronger. But the new rules have wreaked havoc with the timing of jet transactions. 

Here’s why: to be eligible to deduct 100 percent of the purchase price of an aircraft in the year you acquire it, you must place it in service in a trade or business, and 100 percent of the flights that year must count as qualified business use. To the extent you screw this up with non-business flights, you will forfeit the 100 percent deduction and possibly the availability of bonus depreciation altogether. On the other hand, if you satisfy the 100 percent business-use test in the year you acquire the aircraft, going forward you basically need to satisfy only the requirements for accelerated depreciation (MACRS), which mandates (among other things) only 50 percent qualified business use per annum in subsequent years.

Now, satisfying the 100 percent business-use requirement for an entire year is a major challenge for many jet buyers; they want to fly their aircraft for non-business purposes as well. Eliminating personal use of your new jet for up to an entire year can require enormous willpower. But what if you take delivery of the aircraft in December? Just fly on a business trip or two, put the jet in the hangar until January 1, and (subject to remaining qualified for MACRS in future years) you’re done! 

As a result, many jet buyers now want to make their purchases close to year-end—just in time to fit in those December business flights. (Of course, you don’t want to buy too close to year-end, because you’ll have a problem if, for example, a mechanical issue cancels your flights that month and you can’t place the aircraft in service for business purposes until January.) So the end of 2018 was a hectic time for business jet sales, with many maintenance facilities booked solid with prebuys, and aviation attorneys, acquisition consultants, and brokers scrambling to complete closings. 

It appears it will be like that every year—at least until 2022. Beginning in 2023, bonus depreciation rates will phase down annually from 100 percent, finally disappearing for all aircraft in 2028. On the other hand, the repeal of tax-free exchanges for assets is permanent, so in 2022 Congress will be under significant pressure to reinstate either 100 percent bonus depreciation or tax-free exchanges.