There could be turbulence ahead for private aircraft owners, writes Mike Kosnitzky
Private aircraft acquisitions are soaring, with activity in Europe rising by 4% last year. But whilst the market may be cruising along at present, there could be turbulence ahead in the form of new tax regulations surrounding these purchases - The Tax Cuts and Jobs Act of 2017. At first blush, many of the changes seem to benefit private aircraft owners, but a closer inspection reveals that there are many potential pitfalls for the unwary purchaser.
The new regulations have significantly altered the acquisition process: eliminating tax-free exchanges, modifying depreciation regulations, and limiting the deductibility of business entertainment and commuting expenses. It’s crucial that prospective aircraft purchasers understand the complex ramifications of the new regime.
In years gone by, when an aircraft used in a taxpayer’s trade or business was sold to trade up, the taxpayer could defer the gain on the sale by utilizing the provision that recognized no gain or loss when property held for productive use in the taxpayer’s trade or business was exchanged for property that was “like-kind”. This provision has been eliminated with the new Act, which only permits like-kind exchanges of real property.
Under the new Act, 100% of the cost of an aircraft used in a trade or business may be depreciated during the first year of ownership. This is a useful benefit, but to take advantage of it, taxpayers must comply with stringent rules that limit the allowable depreciation deduction when the aircraft is not predominantly in a “qualified business use”.
Business use for the year must exceed 50% and tax payers should note that there are exceptions to “qualified business use”. These exceptions include, for example: flights provided to a five-percent owner or related person, and flights provided as compensation to other service providers, unless the flights were included in the service provider’s gross income.
It is vital that owners understand and apply these rules every year: if qualified business use falls below the thresholds in any subsequent year, then bonus depreciation taken in prior years will be recaptured.
These rules are complex, and there is a lot of money at stake. To be safe, in the year of acquisition, new owners should not use their aircraft for any personal non-business use, and as much as possible avoid any entertainment or commuting use.
Owners must also be particularly cautious about how much time the aircraft is used for personal uses, including entertainment and commuting. Before the new regime came into effect, the law disallowed entertainment expenses incurred on behalf of existing or prospective clients, and other entertainment – unless business activity was taking place immediately before, after or during the entertainment event.
Now, new rules mean that entertainment expenses are no longer deductible and apply to all aviation related expenses, irrespective of whether they were directly related to a taxpayer’s trade or business. Clearly, some trips can involve both business and entertainment activities so where is the line drawn? Take a round or golf, a party, or a sporting event, for example – business and entertainment come hand in hand. Until guidance is issued, it is reasonable to apply existing rules that look to the primary purpose of the trip from the standpoint of each individual traveler to determine the deductibility of such expense.
The Act has also modified the deductibility of expenses incurred in providing transportation between an employee’s residence and place of employment, unless the transportation related expenses are incurred primarily for the employee’s safety.
The Tax Cuts and Jobs Act of 2017 has significantly altered the landscape surrounding the acquisition and ownership of private aircrafts – it’s a complex field and one fraught with the threat of making an expensive mistake. Given the complexity of the rules and the dollar amounts at stake, those considering an aircraft purchase in the US should ensure they understand the potential benefits and risks of this new piece of legislation.
Mike Kosnitzky is a partner at Pillsbury Winthrop Shaw Pittman LLP