Bonus depreciation is back

Bonus depreciation was introduced in the so-called Job Creation and Worker Assistance Act of 2002 in response to the economic malaise following 9/11. Under that act, if you contracted to purchase a factory-new aircraft on or after 9/11 and satisfied certain other requirements, you could start your tax depreciation with a 30-percent "bonus" amount in year one. Then, in the Jobs and Growth Tax Relief Reconciliation Act of 2003, Congress extended the time periods and increased the bonus to 50 percent.

With the creativity of another Rambo sequel, the Economic Stimulus Act of 2008 resurrects 50-percent bonus depreciation for factory-new aircraft. In this latest incarnation, to be entitled to bonus depreciation, you basically have to enter into a binding contract to purchase the business jet in 2008, and take delivery and place the aircraft in service in 2008 or 2009. (If you entered into a contract before 2008, you should check the rules for "self-constructed property" to see whether your aircraft qualifies.) Pre-owned aircraft don't generally qualify, except for special cases like sale-leaseback transactions.

The term "bonus" has led to misunderstandings. You can't depreciate an amount greater than your tax basis in the aircraft. For example, if you purchase a jet for $40 million, on the five-year MACRS schedule, in most circumstances you'd be eligible to write off 20 percent in the first year (see table). The new act lets you write off 50 percent in the first year and then apply the normal depreciation schedule to the balance. Thus, you can write off $20 million (50 percent) as well as an additional 20 percent of the remaining $20 million in the first year, so your total depreciation for that year would be $24 million (60 percent). What you are doing, then, is not increasing your depreciation, but accelerating it. The value of the acceleration lies entirely in the time value of money.

The theory behind bonus depreciation is fairly obvious. By making the already attractive tax benefits of buying a factory-new aircraft even more enticing, the legislation is supposed to "stimulate" you to buy a new aircraft now, rather than later. And selling more aircraft, in turn, is supposed to stimulate the economy. Obviously, there won't be much stimulation if you've already contracted to buy your aircraft, so the rules generally require that you enter into a binding contract this year.

Back in 2002 and 2003, many people hailed bonus depreciation as a boon for business aviation. It was certainly a boon for aircraft manufacturers, who lobbied for the legislation through the General Aviation Manufacturers Association (GAMA). First, it provided an incentive to buy right away rather than wait until next year or the year after that. Second, by offering the opportunity to use more than three quarters of the depreciation in the first two years, it provided an added incentive to replace the new aircraft sooner rather than later. Moreover, because you buy the aircraft earlier, it will be older faster, warranties will expire sooner and you will naturally think of replacing the aircraft earlier. In theory, all of this may be good for the economy.

But it's not necessarily good for the buyer. What happens when a tax break heightens demand for an aircraft model? You guessed it: discounts go down and prices go up. I wouldn't be surprised if the average buyer in 2003 lost every dime of tax advantage by paying more for the aircraft.

In any case, no one could argue that the business jet marketplace today needs much "stimulus." GAMA reports that business jet shipments in 2007 were up 28 percent over 2006. At this writing, most super-midsize to large-cabin long-range jets are not available for outfitted delivery until somewhere between mid-2011 and mid-2013, and are therefore not eligible for bonus depreciation.

Perhaps the strangest thing is that an aircraft doesn't have to be manufactured in the U.S to be entitled to bonus depreciation. Purchases of aircraft manufactured by Bombardier, Dassault and Embraer, for example, would do more to "stimulate" the economies of Canada, France and Brazil than that of the U.S.-if those manufacturers had any pre-2010 delivery positions.

So is there any good news for business jet buyers in the revival of bonus depreciation? Putting aside whether increased demand will result in higher prices, some smaller jets are currently available for outfitted delivery in 2009, and purchasers who contract in 2008 may qualify for bonus depreciation. In addition, capital improvements made to aircraft can also qualify. When the improvements are significant, bonus depreciation can be an important factor.

If you're thinking about buying an aircraft, you should carefully scrutinize eligibility requirements for the new bonus depreciation. For example, if your airplane doesn't qualify for MACRS because it isn't principally used in a trade or business, bonus depreciation won't be available. The rules vary considerably, depending on the size of the aircraft and whether it's deemed "transportation property" or "self-constructed property." Keep in mind that you can write off depreciation expense only to the extent of business use. You should be wary of "creative" schemes to recast 2007 contracts as 2008 contracts or accelerate aircraft "deliveries" from 2010 to 2009 in an attempt to fit the new rules. And perhaps most importantly, you should calculate the real benefit to you of bonus depreciation. It may be less than you think.