How do bonus depreciation rules affect the tax treatment of aircraft?
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The tax treatment of aircraft under the bonus depreciation rules is governed by a complex interplay of Internal Revenue Code (IRC) provisions, Treasury Regulations, and recent legislative changes. Below is a comprehensive analysis of how bonus depreciation applies to aircraft, with a focus on the requirements, limitations, and practical implications for taxpayers in 2025.
1. Eligibility of Aircraft for Bonus Depreciation
a. General Rule:Under IRC §168(k), bonus depreciation allows taxpayers to deduct a significant portion (up to 100% in some years) of the cost of qualifying property, including certain aircraft, in the year the property is placed in service. For property acquired and placed in service after September 27, 2017, and before January 1, 2023, the bonus depreciation rate was 100%. This rate phases down by 20 percentage points per year: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% in 2027, unless otherwise extended or modified by new legislation.
However, under the One Big Beautiful Bill Act (OBBBA), for property acquired after January 19, 2025, 100% bonus depreciation is restored and made permanent for qualified property, including certain aircraft.
b. Qualified Property:To qualify for bonus depreciation, an aircraft must:- Be tangible property with a recovery period of 20 years or less under MACRS (aircraft generally have a 5- or 7-year recovery period).- Be acquired and placed in service within the applicable timeframes.- Satisfy the “original use” requirement (i.e., the aircraft’s first use must begin with the taxpayer), or, for used property, meet the requirements for used property eligibility (not previously used by the taxpayer, not acquired from a related party, etc.).
c. Special Rules for Aircraft:Certain aircraft with longer production periods may have extended placed-in-service deadlines and may be eligible for higher bonus rates in some years. For example, for aircraft with a production period exceeding four months and a cost exceeding $200,000, the placed-in-service deadline for bonus depreciation may be extended by one year.
2. Predominant-Use Test and Qualified Business Use
a. Listed Property and Section 280F:Aircraft are considered “listed property” under IRC §280F. To be eligible for bonus depreciation, the aircraft must be “predominantly used in a qualified business use” (i.e., more than 50% of the use must be for the taxpayer’s trade or business) in the year it is placed in service.
b. Qualified Business Use:- Defined as any use in the taxpayer’s trade or business (IRC §280F(d)(6)(B)).- However, certain uses by 5% owners or related persons (such as leasing to a 5% owner, or use as compensation) are excluded from qualified business use unless a special 25% test is met (IRC §280F(d)(6)(C)). If at least 25% of the total use is qualified business use other than these excluded uses, then all trade or business use is counted.
c. Failure to Meet the Test:If the aircraft does not meet the more-than-50% qualified business use test in the placed-in-service year, it is not eligible for bonus depreciation and must be depreciated under the Alternative Depreciation System (ADS), which uses straight-line depreciation over a longer recovery period.
3. Recapture of Bonus Depreciation
If the aircraft meets the qualified business use test in the placed-in-service year but fails the test in a subsequent year during the recovery period, the taxpayer must recapture the excess depreciation (i.e., the amount deducted under bonus/MACRS in prior years over what would have been allowed under ADS/straight-line). This recaptured amount is included in income in the year of the business-use shortfall, and the aircraft is depreciated using straight-line for the remainder of its recovery period.
4. Substantiation and Documentation Requirements
Because aircraft are listed property, strict substantiation rules apply under IRC §274(d) and Treas. Reg. §1.274-5. Taxpayers must maintain contemporaneous records for each flight, including:- Date, origin, destination, and purpose of each flight.- Names and business relationship of all passengers.- Allocation of flights between business, personal, entertainment, and commuting use.- Supporting documentation (e.g., calendars, emails, itineraries) to corroborate the business purpose.
Failure to maintain adequate records can result in disallowance of deductions, including bonus depreciation.
5. Interaction with Entertainment and Commuting Disallowance Rules
- Entertainment Use: Under IRC §274(a), expenses (including depreciation) attributable to entertainment use of an aircraft are generally not deductible, even if the value is included in the employee’s income. Only the portion of expenses (including bonus depreciation) allocable to business use is deductible.
- Commuting Use: Expenses for commuting flights are also nondeductible unless an exception applies (e.g., for employee safety).
6. Income Inclusion for Personal Use
When an employee, owner, or other service provider uses a business aircraft for personal purposes, the value of the flight must generally be included in their income as a fringe benefit. The value is typically determined using the Standard Industry Fare Level (SIFL) formula or, if not applicable, the fair market value (charter rate) method.
7. Audit Risk and IRS Scrutiny
The IRS has announced a significant increase in audits focused on business aircraft, with particular attention to:- Proper allocation between business and personal use.- Substantiation of business use and compliance with the predominant-use test.- Correct application of bonus depreciation and recapture rules.- Proper income inclusion for personal use and correct application of entertainment and commuting disallowance rules.
Taxpayers should expect detailed information document requests (IDRs) and should ensure their recordkeeping systems are robust and contemporaneous.
8. Summary of Key Legal Provisions
- IRC §168(k): Governs bonus depreciation, including eligibility, phase-out schedule, and special rules for certain property.
- IRC §280F: Imposes the predominant-use test for listed property (including aircraft) and provides for recapture if the test is not met in subsequent years.
- IRC §274: Disallows deductions for entertainment and commuting use of aircraft and imposes strict substantiation requirements.
- Treas. Reg. §1.274-5: Details substantiation requirements for listed property.
- OBBBA (2025): Restores 100% bonus depreciation for property acquired after January 19, 2025, including aircraft.
9. Practical Considerations and Planning
- Acquisition Timing: To maximize bonus depreciation, consider the acquisition and placed-in-service dates in light of the applicable bonus rates.
- Minimize Personal Use: Limit personal and entertainment use in the placed-in-service year to ensure the aircraft meets the more-than-50% qualified business use test.
- Documentation: Maintain detailed, contemporaneous records for all flights and ensure proper classification of each flight and passenger.
- Review Annually: Reassess business use each year to avoid recapture and ensure continued compliance.
In summary: Bonus depreciation can provide significant upfront tax benefits for business aircraft, but only if the aircraft is predominantly used for qualified business purposes in the placed-in-service year and substantiation requirements are strictly met. Personal, entertainment, and commuting use can jeopardize eligibility and trigger recapture. The IRS is actively auditing this area, so robust documentation and compliance with all relevant rules are essential.
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