The “Small Business Jobs Act of 2010”1 (the “Small Business Jobs Act”) includes some good news for both recent and prospective aircraft buyers. Bonus Depreciation benefits have returned. A significant portion of the new Bonus Depreciation benefits expire at yearend, so swift action on the part of taxpayers is imperative. This article will explore and summarize Bonus Depreciation and will examine some practical considerations for taking advantage of this benefit.Back to Articles
Before exploring how Bonus Depreciation may benefit aircraft owners, letâs examine a few misconceptions about Bonus Depreciation:
First, the term âBonus Depreciationâ is a bit of a misnomer. Bonus Depreciation eligible assets do not generate âmore depreciationâ than non-eligible assets. Bonus Depreciation merely entitles the owner of an eligible asset to realize depreciation benefits more quickly. Simply stated, Bonus Depreciation is âfaster depreciationâ not âmore depreciation.â We will demonstrate how this works later in this article.
A second misconception is that Bonus Depreciation is a âbusiness aviation benefit.â Not true. Bonus Depreciation is available for a wide variety of capital assets. What, then, is Bonus Depreciation? Briefly stated, 50% of the cost of Bonus Depreciation eligible property may be deducted in the year the property is acquired. The remaining 50% of the cost or âbasisâ remains eligible for depreciation in future years according to normal depreciation rules.
In order to be Bonus Depreciation eligible, an asset must be âMACRS propertyâ. This means that property used less than 50% of the time for business purposes and property used predominantly outside the United States will not be eligible for Bonus Depreciation. In addition, in order for an asset to be eligible for Bonus Depreciation, the asset must be ânewâ. Pre-owned aircraft do not qualify.
To illustrate the benefit of Bonus Depreciation, assume that Taxpayer A acquires a new aircraft for $10,000,000. Without Bonus Depreciation, Taxpayer Aâs depreciation schedule for the aircraft will be as shown in Table A.2
Now assume that Taxpayer A acquires the same $10,000,000 aircraft, but that the aircraft is Bonus Depreciation eligible. Taxpayer Aâs depreciation benefits will be as shown in Table B.
As Tables A & B illustrate, Bonus Depreciation provides dramatic tax benefits in the year that an asset is acquired, and results in lower levels of depreciation benefits in the following years. Nevertheless, the total depreciation benefit over the depreciable life of the aircraft remains the same.
Bonus Depreciation may also prove a valuable tool for aircraft owners who are acquiring assets other than whole aircraft. The Serviceâs Temporary Regulations specifically state that fractional aircraft interests do qualify for Bonus Depreciation. Current fractional interest inventory availability makes acquisition of a qualifying fractional interest relatively easy to accomplish. However, in order for a fractional interest to qualify, there may be no previous owner of the share other than the fractional program itself.
In addition, Bonus Depreciation may prove valuable for taxpayers making capital acquisitions related to their aircraft, such as tugs, engine replacements or major avionics or interior upgrades.
TIMING/PLACED IN SERVICE
Letâs now turn our attention to what makes an aircraft or other asset âqualifying propertyâ for Bonus Depreciation purposes. Section 2022 of the Small Business Jobs Act and the Internal Revenue Code set forth specific criteria for âqualifying property.â
Only those aircraft whose original use commences with the taxpayer in 2010 are eligible for Bonus Depreciation. In addition, the aircraft must be âplaced in serviceâ prior to the end of 2010. There are some limited extensions of the 2010 placed in service date for âtransportation propertyâ and âcertain aircraft.â
Furthermore, only aircraft for which there was âno written binding contract for the acquisitionâ¦in effect before January 1, 2008â or for which âa written binding contractâ¦was entered intoâ prior to January 1, 2011 will qualify for Bonus Depreciation.
Long delivery backlogs in previous years made it extremely difficult to find an aircraft which could meet both the contract formation and placed-in-service requirements. However, the current economic slowdown has freed up many delivery positions. As a practical matter, it is now possible to enter into a contract this year and still meet the relatively short-placed in-service deadlines.
Even though the Small Business Jobs Act did not become effective until September 27, 2010, aircraft acquired in 2010 prior to the date the legislation was signed into law are eligible for Bonus Depreciation. This will benefit not only those owners who purchased new aircraft in early 2010, but may also benefit aircraft operators who leased the acquisition of a new aircraft. Such lessees may be able to convince their lessors to re-price their lease to reflect the enhanced levels of depreciation available to the lessor.
The Small Business Jobs Act extends the placed-in-service date through 2011 for two types of aircraft, âtransportation propertyâ and âcertain aircraft.â
The statute and regulations do not provide much guidance as to what constitutes âtransportation propertyâ other than to say that âtransportation propertyâ includes tangible personal property used in the trade or business of transporting persons or property. Presumably, this would include an aircraft that is used predominantly for charter missions.
It is not likely that an aircraft used less than half the time in charter service will qualify. Although the-in-service date is extended through 2011 for transportation property, the Bonus Depreciation benefit is limited âonly to the extent of the adjusted basis attributable to manufacture, construction or production before January 1, 2011.â
The placed-in-service requirement is also extended through 2011 for âcertain aircraft.â
âCertain aircraftâ are defined as aircraft which are not âtransportation property,â which cost more than $200,000 and have an estimated production period exceeding four months. Virtually all jets and turboprops meet these criteria. In addition, at the time of contract for purchase, the purchaser is required to make a non-refundable deposit of at least the lesser of 10% of the cost or $100,000.
Note should be taken of the fact that although the placed-in-service date is extended through 2011 for âtransportation propertyâ and âcertain aircraft,â the other Bonus Depreciation eligibility requirements still apply. Thus, for example, a charter aircraft contracted for in 2007 would not, absent another exception to the general rules, qualify for Bonus Depreciation.
The Small Business Jobs Act may provide some unexpected tax benefits for purchasers who entered into their delivery contracts as far back as 2008. Such long-term contract positions which deliver in 2010 are now Bonus Depreciation eligible. These aircraft would not have qualified for Bonus Depreciation prior to the enactment of the Small Business Jobs Act.
For example, an aircraft contracted for in 2008 which is neither âtransportation propertyâ nor a âcertain aircraftâ scheduled to be placed-in-service in 2010 would not have qualified for Bonus Depreciation. With the extensions of placed-in-service dates in the Small Business Jobs Act, these aircraft will n
ow qualify for Bonus Depreciation.
Purchasers of aircraft acquired pursuant to contracts entered into in prior years should review their situations as their aircraft may now be eligible for Bonus Depreciation.
SELF CONSTRUCTED PROPERTY
âSelf constructed propertyâ is granted some relief from the requirement that there be no written binding contract in place at the beginning of 2008 if the manufacture, construction or production of the property begins on, or after January 1, 2008 and prior to January 1, 2011.
The Temporary Regulations include âproperty that is manufactured, constructed or produced for the taxpayer by another person under a written binding contract that is entered into prior to the manufacture, construction or production of the property for use by the taxpayerâ¦â within the definition of âself-constructed property.â As few new aircraft are being built on spec, many business aircraft would seem to meet this criteria.
In order to qualify, the production of the aircraft would have to begin in, or after 2008 and be completed by the end of 2010. The Temporary Regulations state that âconstruction of property begins when physical work of a significant nature beginsâ and that âphysical work of a significant nature will not be considered to begin before the taxpayer incurs or paysâ¦ more than 10 percent of the total cost of the propertyâ or the taxpayer is able to demonstrate qualification of their purchase under a âfacts and circumstancesâ test.
Therefore, aircraft whose production began in 2010 or for which only small payments were made, or relatively minor amounts of work completed in prior years may qualify for Bonus Depreciation as self-constructed property.
WRITTEN BINDING CONTRACT
In past years historically long delivery backlogs combined with the âwritten binding contractâ requirement prevented many new aircraft contracts from qualifying for Bonus Depreciation.
For example, absent another exception to the general rules, an aircraft contracted for in 2007 would not qualify for Bonus Depreciation even if placed in service in 2010. However, the Temporary Regulations define âwritten binding contractâ in a manner which might allow many older aircraft contracts to qualify for Bonus Depreciation.
If, upon breach of the contract by the seller/manufacturer, the contract provides for a full refund of the purchase price in lieu of any other damages allowable by law, the contract is not considered to be a âwritten binding contract.â
Many new aircraft contracts have provisions which limit a buyerâs remedy to a refund of any progress payments made. Although both the buyer and seller in a new aircraft contract will no doubt consider that they have an effective and binding contract, the Temporary Regulations may allow the buyer to reach the conclusion that the contract is not âbindingâ within the meaning of the statute. Such aircraft may qualify for Bonus Depreciation, but the reader is cautioned to take such a position only after careful examination of their contract and the law and regulations.
How does Bonus Depreciation impact holders of delivery positions who wish to sell their positions and buyers of such positions? Long delivery backlogs often provided incentive for persons to enter into new aircraft contracts with the intention of selling their positions to potential end users. In addition, the current economic slowdown has caused many taxpayers with long-term delivery positions to re-evaluate their need for a new aircraft and to consider the sale of their delivery positions.
There are a variety of methods used to accomplish the sale of an aircraft delivery position including, sales of interests in an LLC which owns a delivery position, assignments of the purchase contracts, so-called âback-to-backâ transactions and eventual re-sales of a newly acquired aircraft.
Taxpayers should be aware that the Service may challenge the eligibility for Bonus Depreciation of such transactions as these transactions seem to fall outside of the stated Congressional and Presidential intentions of stimulating the production and sale of new capital assets. The success or failure of any such challenge is likely to hinge on the particular facts and circumstances and the method of documentation of each transaction.
An examination of the various types of assignments and the availability of Bonus Depreciation is beyond the scope of this article, but anyone considering such a transaction should do so with an awareness that they may be taking an aggressive reporting position and are relying upon interpretation of the legislation in such a way that runs counter to the stated purpose behind the adoption and extension of Bonus Depreciation.
Sale leaseback and syndication transactions continue to enjoy favorable treatment provided by the Temporary Regulations. Aircraft originally placed in service by an end user and sold to a leasing company and leased back to the end user within three months after the original placed-in-service date remain eligible for Bonus Depreciation.
Aircraft sold from one leasing company to another within three months of the original placed-in-service date remain eligible for Bonus Depreciation in the hands of the second leasing company. In addition, it is possible to âstackâ a sale-leaseback and syndication transaction such that the syndication transaction may occur up to six months after the original acquisition of the aircraft.
The Small Business Jobs Act provides some significant benefits for purchasers of new business aircraft. Contracts must be in place by year-end for all aircraft. Aircraft which do not qualify as either âcertain aircraftâ or âtransportation propertyâ must also be delivered and placed in service prior to the end of the year. Consequently, swift action is necessary to qualify before the latest window of Bonus Depreciation eligibility closes.
In conclusion, the Stimulus Package provides some significant benefits for purchasers of new business aircraft. This article has highlighted some of the strategies for taking Bonus Depreciation on a new aircraft purchase. The reader is cautioned that this article is not intended to be more than an introduction to the topic.
Anyone considering taking Bonus Depreciation benefits for a new aircraft should not only read the law and Temporary Regulations, but should also retain independent legal, tax and accounting advice to determine if their aircraft is eligible for Bonus Depreciation, and to properly structure their acquisition.3
1. For the full text of the legislation, see H.R. 5297: http://www.rules.house.gov/111/LegText/111_hr5297_snamnd.pdf
2. The Tables provided illustrate the benefit of depreciation and Bonus Depreciation for a ânoncommercialâ aircraft depreciated on a five-year schedule. âCommercialâ aircraft, generally including aircraft used predominantly in charter service, will be depreciated over a longer seven-year schedule. The levels of depreciation in each year will be lower for seven-year property, but the impact of Bonus Depreciation will be similar and the aircraft will remain eligible for depreciation benefits equal to 100% of the cost of the aircraft.
3. Please Note: Bonus Depreciation has previously been available in years 2003 through 2009. Although the basic principles of Bonus Depreciation in prior years are essentially the same as in its current iteration, the eligible dates for âoriginal use,â âplaced in serviceâ and contract formation are different.