How to avoid losing aircraft depreciation deductions
You’ve probably heard that you can’t write off your jet if business use doesn’t exceed 50 percent. That’s not true.
One of the most pervasive myths about the taxation of business jets in the U.S. is that the owner isn’t entitled to any deductions unless more than 50 percent of the aircraft’s usage is in a trade or business. I hear this regularly from people who are contemplating a jet acquisition but worry that they won’t be able to take any tax deductions for it because less than half the usage will be business-related. Like many myths, this one contains a nugget of truth, as I’ll explain presently. But it’s incorrect to assume you can’t write off anything if your business use doesn’t exceed 50 percent.
Within reason, Uncle Sam intends to tax just your income that is net of the expenses you incur in generating it, and that includes the costs of operating a business jet. Thus, even if only a minority of your flights are business-related, the expenses associated with those flights may well be deductible.
One of the biggest aircraft expenses (and thus deductions) is depreciation. Since the useful life of a business jet extends over many years, the IRS won’t let you write off the whole purchase price in the year that you buy it, but the tax agency will let you write off the airplane much faster than it actually depreciates in the market. Many businesses can write off an aircraft in six years using a schedule published by the IRS under the Modified Accelerated Cost Recovery System (MACRS). This permits an accelerated, front-loaded write-off, whereas the straight-line schedule requires you to deduct equal amounts annually over a longer period. In many cases, MACRS allows you to write off more than half of the aircraft’s adjusted basis—generally the purchase price—in the first two years.
If this isn’t fast enough for you, you may be able to accelerate deductions even further. “Bonus depreciation” is still available for some factory-new aircraft to be delivered this year, and you may qualify for it if you also qualify for MACRS. Bonus treatment provides a tax write-off of as much as 60 percent of what you pay for the aircraft in 2014. The table below shows typical comparative effects of straight-line, MACRS and 50 percent bonus depreciation for noncommercial aircraft.
I said earlier that the 50 percent myth contained a nugget of truth, and here it is: to qualify for MACRS, the airplane must be used predominantly (more than 50 percent) in a trade or business of the taxpayer. To meet this test, many buyers focus on the year they placed their aircraft in service, especially when it is delivered close to year-end. For example, if you place a jet in service in December and mostly fly non-business trips for the holidays, it won’t meet the 50 percent test for that year and won’t ever qualify for MACRS—or bonus depreciation, for that matter.
But the test doesn’t end with the first year. Suppose in the third taxable year that you own the aircraft only 30 percent of your usage is business related. You’ll still be entitled to deduct depreciation on the aircraft, but—since you failed the 50 percent business-use test—not on the MACRS schedule. On the contrary, you’ll have to go back and recapture the excess of MACRS (including bonus) depreciation over straight-line and use the straight-line schedule going forward. Note that you actually got the benefit of MACRS (essentially the time value of the money you didn’t pay in taxes) for the first two years; but the MACRS schedule is cut off early and your deduction is recaptured. (Had you not flunked the 50 percent test, it wouldn’t be recaptured until you sold the aircraft, subject to a like-kind exchange or other tax shield.)
It gets worse. A special federal tax rule says that flights provided by the employer as compensation for services can count as “business use” only if at least 25 percent of the airplane’s total use in the tax year represents what business aviation tax expert Stewart Pearl calls “hard” business use: use in the company’s trade or business that doesn’t include leasing to 5 percent owners and related persons or represent compensation to such individuals for services.
To see how this 25 percent rule works, suppose the CEO/5 percent owner uses the company jet for a vacation flight and reports taxable income using the advantageous SIFL formula provided by the IRS. [See Jeff Wieand’s column on “Borrowing the Company Jet”] The flight would count as business usage for purposes of the 50 percent test because it constitutes compensation for services, but only if at least 25 percent of the total use of the aircraft during the tax year was “hard” business use. Failing this 25 percent test in the first year means the aircraft doesn’t qualify for MACRS (or bonus) depreciation…ever. Failing the test in a subsequent year means that the company not only will forfeit accelerated depreciation for that year and going forward, but also that the company will have to recapture accelerated depreciation (including bonus depreciation) previously taken as described above.
Well, if you needn’t have more than 50 percent business use to take advantage of tax write-offs, is there any minimum percentage of such use required? If 5 percent of my annual usage is business, can I write off 5 percent of my jet expenses? Attorney Pearl points out that if 5 percent of the flights are revenue-generating charter and the balance are personal, you should still be able, in theory, to deduct expenses of the charter flights against the charter income.
There’s another 50 percent test for MACRS worth mentioning. In addition to being used more than 50 percent for business, the aircraft must be used more than 50 percent in the U.S.
In sum, the 50 percent business-use test (either directly or via the 25 percent rule) can have serious tax consequences, even if it doesn’t preclude tax deductions on the aircraft altogether, as the myth would have it. The moral: pay close attention to your business use of the aircraft in each tax year to ensure that you continue to satisfy the requirements for MACRS.
Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.