On September 8, 2003, the Internal Revenue Service issued official guidelines on Bonus Depreciation. These guidelines, issued in the form of Temporary Regulations, were the first detailed statements issued with respect to the Bonus Depreciation benefits conferred by Congress in the previous legislative sessions.[1] Briefly stated, the recently enacted Bonus Depreciation legislation makes it possible for taxpayers to realize first year tax deductions of up to 60% of the cost of acquiring a new business asset, including a new corporate aircraft.[2] These voluminous Temporary Regulations included some unanticipated benefits of particular interest to the business aviation community. This article will describe four of these benefits, namely, (1) the availability of Bonus Depreciation for personal aircraft converted to business use, (2) the application of Bonus Depreciation benefits to purchasers of fractional interests and demonstrator aircraft, (3) expanded Like Kind Exchange benefits and (4) increased timing flexibility for taxpayers who lease their business aircraft. Of particular interest is the fact that these Temporary Regulations are generally retroactive for all qualifying property acquired on or after September 11, 2001.
AIRCRAFT CONVERTED FROM PERSONAL TO BUSINESS USE
The Bonus Depreciation benefits are generally available for new aircraft acquired after September 10, 2001 (for the 30% Bonus) or after May 5, 2003 (for the 50% Bonus). However, the Bonus Depreciation benefits are only available to the first taxpayer to place the qualifying asset in service. The Temporary Regulations make it clear that an aircraft initially acquired by a taxpayer for personal use and subsequently converted to business use or for the production of income by that taxpayer still satisfies the “original use” requirement for qualifying property at the time of conversion. Thus an aircraft previously used for personal reasons remains eligible for Bonus Depreciation treatment in the year the aircraft is converted to business or income production purposes.
The Temporary Regulations offer some interesting opportunities for owners of aircraft that are currently being used for personal use. Such taxpayers have the ability to convert their aircraft to business or income producing use and qualify for first year Bonus Depreciation benefits of up to 60% of the cost of their aircraft. Owners of personal use aircraft may find it advantageous to consult their tax advisers to determine if conversion to business use or increased charter activity might make such conversion or charter utilization worthwhile.
PURCHASERS OF FRACTIONAL INTERESTS AND DEMONSTRATOR AIRCRAFT
A fractional aircraft interest used for business purposes now clearly qualifies for Bonus Depreciation treatment in the hands of the Fractional Interest Owner. The Temporary Regulations clearly establish that the purchaser of a fractional interest in an aircraft is considered the “first user” of the interest. If the purchase otherwise satisfies the requirements for “qualified property,” the fractional nature of the interest does not negatively impact the availability of the Bonus Depreciation benefit. Each “first owner” of a fractional interest may qualify as the beneficiary of the applicable 30% or 50% Bonus Depreciation benefit for the full purchase price of the fractional interest. Furthermore, so long as the Fractional Program Provider continues to hold the remaining interests in an aircraft after sale of one or more fractional interests in an aircraft to a Fractional Interest Owner, the remaining fractional interests in that aircraft continue to be eligible for Bonus Depreciation benefits in the hands of subsequent purchasers.
Although the text of the Temporary Regulations does not specifically address the particular concerns of purchasers of demonstrator aircraft or aircraft from dealer inventory, one of the Examples cited in the Temporary Regulations does address a lingering issue in the business aviation community concerning the eligibility of these types of aircraft for Bonus Depreciation. The Example provided by the Service is analogous to an aircraft dealer or airframe manufacturer that uses an aircraft in its inventory as a “demonstrator” aircraft to potential purchasers in the ordinary course of its business. The Example makes it clear that the demonstrator aircraft in the hands of a subsequent purchaser remains eligible for Bonus Depreciation. The purchasing taxpayer remains the “first user” of the aircraft and, assuming the aircraft otherwise meets the requirements for qualified property, the aircraft will be eligible for Bonus Depreciation in such purchaser’s hands. By analogy, aircraft held in inventory and primarily for resale by an aircraft manufacturer, broker or dealer will still qualify for Bonus Depreciation in the hands of the first purchaser of that aircraft.
LIKE-KIND EXCHANGES
Pursuant to Section 1031 of the Internal Revenue Code, under certain circumstances a taxpayer may defer the payment of capital gains taxes realized in connection with the sale of a business aircraft if the taxpayer acquires another aircraft to replace that aircraft. The difference between the cost of the new aircraft and the depreciated value of the old aircraft has always been eligible for depreciation. That value is clearly eligible for Bonus Depreciation treatment. But, depending upon how long the old aircraft was owned, the taxpayer may or may not have exhausted all of the available depreciation benefits associated with ownership. To the extent that at the time of the sale of the old aircraft, the taxpayer has not fully depreciated the value of that aircraft, that portion of the old aircraft’s value that has not been depreciated may be added to the excess value of the new aircraft for purposes of determining the amount eligible for Bonus Depreciation.
For example, a taxpayer acquired a Model 100 aircraft in 1999 for $5,000,000. Through the 2002 tax year, the taxpayer has claimed $3,500,000 in depreciation benefits related to the Model 100 leaving a remaining tax basis of $1,500,000 in the Model 100. In June 2003, the taxpayer acquired a new $10,000,000 Model 200 aircraft by exchanging the Model 100 and the payment of cash utilizing a Section 1031 Like Kind Exchange. Assume that the Model 200 met all of the other requirements for 50% Bonus Depreciation eligibility. For 2003 Bonus Depreciation purposes, the taxpayer’s tax basis in the new Model 200 is $6,500,000 ($1,500,000 in “carryover basis” from the Model 100 plus $5,000,000 in “excess basis,” or the difference between acquisition cost of the Model 200 over the Model 100). The taxpayer can claim Bonus Depreciation in the amount of 50% of the tax basis in the Model 200. Therefore, the taxpayer will realize a Bonus Depreciation benefit of $3,250,000 in 2003, the year the Model 200 was acquired.
LEASED AIRCRAFT
The Bonus Depreciation laws enacted by Congress provide that if a qualified aircraft placed in service by a taxpayer on or after the applicable dates (September 11, 2001 for 30% Bonus Depreciation property and May 5, 2003 for 50% Bonus Depreciation property) and the aircraft is sold to a company that leases the aircraft back to the taxpayer within three months of the original acquisition (a “sale-leaseback” transaction), the lessor is still considered the original user of the aircraft and the aircraft will remain eligible for Bonus Depreciation.
The Temporary Regulations expand this statutory exception even further. If the original lessor subsequently sells the aircraft to a successor lessor within three months after the original lessor acquired the aircraft and the user/lessee does not change during this period, the successor lessor is considered the original user of the aircraft and the aircraft remains eligible for Bonus Depreciation treatment in the hands of the successor lessor. Under the Temporary Regulations, aircraft that are the subject of saleleaseback transactions may benefit from both the three month extensions for sale-leasebacks and an additional three month extension for the sale from the original lessor to a successor lessor. Thus, a total of six months may elapse between the time that the lessee/user acquires an aircraft and the time that a successor lessor acquires the aircraft and the aircraft will remain eligible for Bonus Depreciation. The Temporary Regulations also make it clear that if the user/lessee would not have been entitled to take Bonus Depreciation benefits with respect to its aircraft, the lessor or any subsequent lessor may not take Bonus Depreciation benefits with respect to that aircraft.
The net effect of these aspects of the Temporary Regulations is that it may be easier for aircraft owners to obtain lease financing for their aircraft. In addition, many aircraft owners may not be able to realize the full effects of Bonus Depreciation in the first year of ownership due to insufficient taxable income or Alternative Minimum Tax problems. A taxpayer in such situation may elect to enter into a sale-leaseback transaction rather than continue to own the aircraft. The lessee may thus be able to realize the full first year benefits of Bonus Depreciation in the form of lower monthly rent payments and related improvement in cash flow.
SUMMARY
The recently enacted Temporary Regulations provide some powerful incentives to purchase a new aircraft. These benefits come in several forms and may be of use to many different types of owners. For example, aircraft owners who currently use their aircraft for personal reasons may be incented to pursue charter use of their aircraft. Purchasers of fractional interests and demonstrator aircraft can acquire their interests with confidence that they will receive the benefits of Bonus Depreciation. Like kind exchanges now yield unexpected Bonus Depreciation benefits. Finally, aircraft owners who are unable to realize the full benefits of Bonus Depreciation may be able to receive the benefits of Bonus Depreciation by leasing their aircraft.
Taxpayers should also keep in mind that the regulations referred to in this article are in fact “Temporary Regulations.” Temporary Regulations may be relied upon for three years after they are implemented. If Temporary Regulations are not made permanent prior to the expiration of three years, they expire and have no further force or effect. In addition, the Service has the ability to make changes to these regulations before they become permanent.
The particular facts and circumstances relating to the acquisition and use of an aircraft continue to have a significant impact on a taxpayer’s eligibility to utilize Bonus Depreciation. Those considering the acquisition of a new aircraft should consult their tax and legal advisors to determine if Bonus Depreciation will be available with respect to their newly acquired aircraft and to verify that they will be able to utilize such Bonus Depreciation to full advantage. Due to the retroactive nature of the Temporary Regulations, taxpayers should also consider revisiting their tax returns for the past several years to determine if they may have qualified for additional tax benefits in those prior years.
[1]A complete text of the Temporary Regulations, Section 1.168(k)-1T may be accessed at “www.ustreas.gov/press/releases/js703.htm”. The Temporary Regulations total approximately 89 pages of text and preamble explanation.
[2]Please note that Bonus Depreciation benefits are only available for “new aircraft” which satisfy certain other statutory require- ments. For a discussion of Bonus Depreciation benefits as they relate to business aircraft see my other articles on the Hinckley Allen & Snyder, LLP website. To view, visit www.haslaw.com . Link to my bio under “Our Attorneys” and click “more.” A list of Bonus Depreciation related and other articles will appear.