‘Would you like to own a private jet and pay less in taxes?’
Bonus depreciation: Myths, legends and facts
The promise of saving taxes lures many people into buying a jet. But it only makes sense if you fly enough and you should not rely on ‘cocktail napkin accounting’. Words: Mike Francis, Vmax Aviation Advisory
Living the dream: But at what cost?
‘Would you like to own a private jet and pay less in taxes?’
Bonus depreciation: Myths, legends and facts
The promise of saving taxes lures many people into buying a jet. But it only makes sense if you fly enough and you should not rely on ‘cocktail napkin accounting’. Words: Mike Francis, Vmax Aviation Advisory
Living the dream: But at what cost?
IT IS A safe bet that nearly anyone would say yes to the question. Unfortunately, buyers seeking a tax write-off as their main goal for acquiring a jet are often disappointed that the expense of ownership exceeds the tax benefits generated. Those who fit this profile and whose tax due diligence qualifies as ‘cocktail napkin accounting’ will quickly find that the once-attractive cocktail has a rather bitter aftertaste.
With proper planning, an aircraft can provide some tax benefits; however, the tax benefits are generally outweighed by the total cost of ownership. How, you ask? Pour yourself your favourite cocktail, grab a napkin and a calculator and let’s walk through this.
To explore, let’s use the assumptions from our generic case study. Our buyer is spending $15m on an aircraft and will sell it five years later for $10m, as set out in Table 1. They will fly it around 250 hours a year with annual expenses of $2.5m. The general rule of thumb is that if you’re flying: 0-50 hours per year, you should use charter or buy a jet card. If you are flying 50-200 hours a year, fractional ownership makes sense; and greater than 200 hours you should consider full ownership. The mission and need for the aircraft should drive any decision to purchase a plane, not any perceived tax benefit. As an investment, business jets have two things working against them: first, they all lose value and second, they are extremely expensive to own and operate.
To explore, let’s use the assumptions from our generic case study. Our buyer is spending $15m on an aircraft and will sell it five years later for $10m, as set out in Table 1. They will fly it around 250 hours a year with annual expenses of $2.5m. The general rule of thumb is that if you’re flying: 0-50 hours per year, you should use charter or buy a jet card. If you are flying 50-200 hours a year, fractional ownership makes sense; and greater than 200 hours you should consider full ownership. The mission and need for the aircraft should drive any decision to purchase a plane, not any perceived tax benefit. As an investment, business jets have two things working against them: first, they all lose value and second, they are extremely expensive to own and operate.
Compare this with another investment class, such as commercial real estate, which can have similar capital costs and offers tax depreciation benefit. Real estate, however, typically appreciates and can produce positive cash flow. For aircraft owners who can justify the expense of aircraft ownership as a business tool, the benefits from tax depreciation are compelling and can become a factor for those considering an aircraft acquisition. However, for those seeking just a tax write-off with minimal business utilisation, the picture isn’t always so rosy.
Hands on accounting: It’s key to consider maintenance costs for the aircraft’s engines, airframe and systems.
Hands on accounting: It’s key to consider maintenance costs for the aircraft’s engines, airframe and systems.
Ownership for annual utilisation above 200 hours typically outperforms other options for the most part because the higher capital and fixed costs from owning your own jet can be amortised over a greater number of hours. In addition, the increased operational efficiencies from having direct control over the plane is also an attractive incentive at higher utilisation levels.
With that said, the attractiveness of the tax benefit (and frankly, the appeal of owning a jet), can lead those with annual utilisations of below 200 hours per year to pursue acquiring an aircraft. Furthermore, some individuals believe they will ‘make up’ for their low utilisation by putting a significant amount of charter on the plane. Their reasoning seems to go that income from the charter will offset their expenses, providing them with the ability to use tax depreciation as an offset (more on that later) and maybe even make a profit. Whether or not charter can provide breakeven, if not net profitable economics, is a debate for another article. However, owners considering this scenario should be fully aware of all costs associated with aircraft ownership.
What should be considered? To find the answer, let’s look at Table 2, which shows the ownership costs based on our first assumptions. Potential income from charter has been left out of the equation. All cash flows are expressed with non-adjusted dollars as all owners’ financial assumptions are unique.
What do the cash flows tell us? There is some benefit from the tax depreciation, but between the loss in value of the aircraft plus the ownership expenses, the tax benefits are outweighed. If the aircraft’s annual utilisation is greater than 200 hours per year for business flights, then the mission for the plane makes sense, although the aircraft will still run at an economic loss.
200 hours of annual utilisation
However, for an owner who falls below 200 hours of annual utilisation, not only do the basic economics of owning the aircraft become questionable, but if the rationale to acquire the plane is primarily for the tax benefits, that owner will likely run a significant loss on the plane. Charter income could certainly make up for some of the economic loss, but it’s debatable if an owner can truly break even when factoring in the total cost of ownership and the ebbs and flows of charter demand.
Furthermore, if the income generated by chartering the plane is what is being used to provide the basis for tax depreciation, owners should be aware of how the income generated by the plane is classified.
While tax depreciation benefits are available for some business aircraft usage, aircraft owners should be aware of other income tax regulations that can limit its applicability. A specialist in aviation tax can provide an owner with more insight into this, but a common issue is the application of Passive Activity Loss regulation as it relates to charter/lease income. Generally speaking, passive losses can only be offset by passive income. If an aircraft is leased to a charter company for Part 135 (charter) operation, and not operated by the taxpayer for his or her own business travels, the amount of tax deprecation benefits available to an owner might fall short of their expectations.
If you’re nearing the end of your cocktail, let’s recap: Bonus depreciation provides some economic benefit to the owner of an aircraft, but not all owners can take advantage of this benefit. In any case, the benefit does not offset the total cost of ownership of an aircraft.
Aircraft charter can provide a partial offset against an aircraft’s fixed costs, although this will vary across individual owners. Regardless, the net return on investment in Table 2 shows the delta an owner would need to generate with net income produced by the aircraft in order to make the plane a cash flow neutral investment. As you can see, the amount is not insignificant.
Still considering acquiring an aircraft to mitigate taxable income with the hope of breakeven economics? Better make the next cocktail a stiff one.
“Aircraft charter can provide a partial offset…”
Mike Francis, Vmax Aviation Advisory
