Income Taxes for Aircraft Owners webinar

[Music] welcome to tonight's webinar the third in a continuing series from AOPA is pilot protection services tonight's talk is on income taxes as related to aircraft ownership I'm Chad Mayer an attorney with AOP as legal services plan joining me tonight is Ray's speciality and other attorney with the plan in addition to being an attorney ray is also a CF double-eye and a CPA so he's got a wealth of knowledge to share on this topic thanks again for joining us and let's dive right in Thank You Chad good evening everyone and just want to first note that the discussion for this evening is really related to the kind of GA aircraft that we see most often in our line of work and that is usually the smaller piston-driven aircraft that a business owner or somebody who's working in the business might be using so the the setting for the discussion is sort of the typical smaller type GA aircraft where in fact you're talking about an owner and pilot operating the aircraft himself not a trained crew right right so that's our setting and what I've got lined up is really three different segments for this evening the first segment will be really directed at aircraft related business expenses so there we'll be talking about if in fact you own or you operate a business what kind of expenses might you be able to deduct and what kind of issues might you face as you use your aircraft in furtherance of your business the second segment will largely be related to the kind of typical challenges that we see in our office that the IRS will bring for an aircraft owner or a business owner who is looking to take deductions for their aircraft they typically fall within certain parameters and then finally I'd like to go over with all of you a little bit about what happens when you're buying and selling an aircraft what kind of considerations need to be thought through what do you need to reflect on as you enter into that buy sell transaction whichever side of that you might happen to be on alright ray thank you for that overview and just a reminder to all of you out there you can subscribe to a o P aids pilot protection services YouTube channel with that red subscribe button and you can reach us in the office Eastern Time 8:30 a.m. to 6:00 p.m. 800 us a a o PA alright so right let's dive into the first segment aircraft related business expenses sure in the the most important section the one that really controls most of the types of deductions and the issues that we see is actually Internal Revenue Code section 162 it's really rather simple section in terms of what it's saying but there's a lot packed into this particular section as you can see on the screen there it's basically saying that the IRS the Internal Revenue system and the Internal Revenue Code is going to allow for a deduction of all and these words are important ordinary and necessary expenses that are paid or incurred and this is also important in carrying on a trade or business so that's where we're going to be focusing a lot of the attention here your expenses have to be related to a trade or business now when you look to break this down the two real issues that we're talking about here are going to be are the expenses ordinary and then are they in fact necessary and an additional test that they've bought up is whether or not the expenses are reasonable so if we can bring up the next slide there you want to take a look here to see were you involved in a trade or business because that's really a critical threshold question if you were not involved in a trade or business none of these expenses could be deducted next were they ordinary necessary and like I said this word doesn't show up in the code but it has showing up in subsequent cases and that is were the expenses reasonable so we've seen that come up actually that one the reasonable and this test comes up often more often than you think interesting thank you Ray all right so let's take a look because of the I would almost say the built-in ambiguity and maybe the purposeful ambiguity in that section 162 the way we wind up having to as lawyers and cpa's trying to interpret all of this is through case law when you see a Code section drafted like that ordinary necessarily what does that mean right well it means what the courts thinks it means right so we have to delve into cases that have been developed and that have come up over many years and when it comes to aircraft and aircraft related deductions I've tried to just put together a few to note for you this evening that are widely used as we're looking to justify taking deductions for purposes of the ordinary piece one case from back in 1992 which is still good law is the Marshall case and in that case the courts took a look at someone who was using an aircraft for purposes of their business use and they pretty much said that in this day and age the use of a private aircraft for business purposes is settled as being ordinary so with that case came a real resolution to that particular issue of whether or not the expenses were ordinary another sort of landmark case in this particular realm was the sardor case that case dealt with the issue of whether or not expenses were necessary in the sadr case you were dealing there with an insurer salesman who had a very large geographic territory to deal and he made use of his aircraft on a regular basis to visit with clients to visit with vendors to advance his own business enterprises in many different ways so he made really good use of his airplane the IRS challenged his expenses and in that case the tax court took a good look at it and they said you know these kinds of expenses the kind of expenses that you're incurring when you're using an airplane in a setting like that and that kind of context are going to be considered necessary for the furtherance of your business the next you know series of cases that I noted in that slide dealt with that totally case driven question of whether or not the expenses would be considered reasonable now this came up the reasonableness question did not does not again show up in the statute but it showed up in subsequent case law and there were those three cases that I noted in the slide there that talked about this particular issue of reasonableness which does often come up the first case there which was the noise case as a significant case largely because what it does is it settles the important issue of whether you should consider depreciation expense when you're determining reasonableness and anything it is because in this and it's a subtle distinction that even a lot of IRS agents don't get until you bring it to their attention understandably because this is not the kind of thing that they're looking at regularly in noise it was very unusual we had a taxpayer there who was basically expensing war for his aircraft use than his salary which was rather modest from a start-up company but what he was arguing and the IRS was challenging that of course and what he was arguing is that when the IRS looks at the question of reason they should not look at the rather huge amount that was being taken for depreciation and the tax court looked at that and good for aircraft owners they agreed with them they said look IRS certainly depreciation is going to be looked at in terms of being a deduction but when it comes to examining the question of reasonableness you can't look at depreciation because you the IRS set the rates for depreciation and depreciation really is a separate kind of deduction under the tax code it's actually section 168 instead of 162 so important distinction then it is because depreciation is often going to be your biggest expense so that's why it is so critical to leave that out of the equation when you're considering reasonableness the curves that case that's mentioned next is actually great and that it reaffirmed noise and it did so in the context of United States Court of Appeals which is an even higher court than the Tax Court so I think that that's fairly settled law at this point and then finally one other case I mentioned down there Richardson interesting case it has some limitations to it but in that case and this is unusual for the courts to do it this way they said look we're gonna be willing in a case that involved someone whose aircraft related expenses involved I think in this case there was twenty six percent and seventeen percent of gross revenue we consider that to be reasonable now whether that's a bright-line test for everybody I would probably say no but whether it's helpful or as you think about you know what might be considered reasonable I would say yes it does help in that regard certainly and and rate let me ask have we ever seen a case where a certain percentage was found to not be reasonable I can't say that I've seen one where they said a certain percentage was not reasonable no they might say that it's a ah be right as we'll go over later they might say that you haven't been able to justify your expenses but that tests gives us a little bit of help in determining how the courts might look at this certainly thanks for taking us through that and let's move on to flight training and proficiency expenses you bet because this does come up a lot so as you can see in the next slide what we've taught what we're talking about here is really a regulatory section that guides us here again because when you look at the question of what's ordinary and necessary it's so broad and somewhat vague that you need some guidance so the IRS has put together a bunch of rules related to and regulations related to educational expenses and what they've said is that flight training expenses are not we always want to start unfortunately with the negative they're not going to be deductible if they qualify you for a new trade or business or whether they're required to meet the minimum requirements of your employments so if in fact you are getting a certificate in order to do the minimum to get to the minimum threshold for whatever it is you're going to be doing that's not going to be deductible okay so that's the first test look at what's not deductible and it is not deductible if it does qualify you for a new trade or business as several ratings and certificates do happen that bring us right they bring us to the threshold of a new profession so it sounds like you're telling me that just like passing the bar exam is not something I could deduct when I got my commercial pilot certificate not deductible I'm sorry to tell you that is the case drat sorry about that but yes if you're in fact getting that initial commercial certificate or I know you're gonna do it and you get that certified flight instructor so today that won't be deductible alright however I would say on the positive note that if you're moving on after getting your initial flight instructor certificate to get a an advanced flight instructor certificate you know perhaps an instrument ocf double eye or an Mei it's at least my opinion that that should be deductible it's interesting there's no cases on that yeah but actually built into the regs there's a section that talks about teachers and as you know teachers often get a certification for either elementary school or for secondary right and built into that reg it says if you've already got your teaching certificate and license let's say for secondary and then you moved on to get one for elementary or a special ed that would be deductible very interesting so if we can make that analogy for flight instructors I think we're going to be in good shape and it seems fair and thankfully it hasn't been tested yet so we were pretty good shape in that regard the other piece of this which says where the positive side of it is where they may be deductible and I've got that on the slide for you as well is where in fact the education or training is in fact necessary to meet the requirements of your employer or the law or is necessary to improve your skills and your current duties most often where this comes in for purposes of aircraft is where in fact you might need to do whatever you need to do to keep up to date with FAA for purposes of currency right so you might need to fly a certain number of approaches if you have an instrument rating you might need to do a certain amount of night flying if you're using it for business in that setting so here in fact you've got an opening for appropriate deductions if you're using your aircraft for business purposes and you're trying to stay current to assist you in business purposes very good thanks for taking us through that ray all right let's move on to depreciation sure and this one we can almost do an entire webinar on this but I'm just gonna try and you you be riveting I assure you but what we can do today is just sort of walk you through the basics here and as you can see there's really three basic modes of what I'll describe as depreciation the depreciation is nothing more than expensing an aircraft over time the IRS dictates to us how long the useful life of an aircraft is whether it has any relation to reality or not and what we do is we live within those regulations and those rules and we expense the aircraft over that number of years the basic fundamental modality for this is what we call makers and that's modified accelerated cost recovery system it's been around since roughly 1986 it had an earlier iteration but that's where we are now and typically for an aircraft it will in fact require that usually for GA aircraft that you depreciate over a five-year schedule and it's a pretty aggressive schedule if you think about it five years for an aircraft prick that's right so it's a big expense think about a $200,000 aircraft being for tax purposes expense to zero over that short period of time so it's a lot of depreciation the other two approaches to depreciating the depreciation that are even more aggressive are what we call a section 179 expense and that has recently been updated with the new tax law it allows you to fully expense in the year of purchase a qualified asset up to a million dollars if the assets worth more than 2.5 million dollars you start to take for every dollar it's above 2.5 you have to reduce the deduction so that could be a very aggressive deduction for somebody who has a lot of revenue and is able to offset it with that expense very aggressive indeed the last ones even more aggressive perhaps and that is and this is very new all came about in December with the tax law changes and this will be important to discuss now and it'll also come up a little later when we're talking about buy sells for aircraft the new provision in the tax code that is really a temporary provision but it's 100% bonus depreciation so basically if you're using an aircraft in your business and it's a qualified use and we could spend forever talking about that but I'm just trying to give you the overview now you could potentially deduct 100% of the value of that aircraft immediately and that is a very large potential deduction Wow previous iterations of this bonus depreciation really limited the deduction only to new aircraft so what's really important about the new tax law is that it allows the deduction for both new and used aircraft and you'll see how that becomes very important a little bit later when we do talk about buy sells on aircraft all right I look forward to diving into that more later you bet we'll be right back after a quick break which addresses the medical benefits available under pilot protection services remember you can reach us during business hours on the East Coast 800 USA AOPA we'll be right back I'd had a cardiac event in 2000 and when I called AOPA pilot protection services and talked to medical lady there Mary Ann was just fantastic I sent the information I had she emailed me back a three-page thing showing me she prepared me for everything that I had to do and I went down and I I got through it I couldn't believe it you know I was thrilled welcome back from the break next up we'll be talking about typical IRS challenges beginning with the hobby loss rule rate please fill us in on that thanks a lot Chad yes and what I wanted to do was now sort of set the stage for the kind of typical challenges the IRS might bring to aircraft expenditures or deductions and as you'll see there's really two there's there could be more but this is the sort of typical case that we see one of them that we will often see is of the IRS saying that hey this really isn't a trade or business remember going back to section 162 there we said the activity had to be a trade or business otherwise it's not deductible and that's exactly what this is saying so section 183 of the code says we're not going to allow you to take deductions for anything that might be considered a hobby so we'll talk about how that challenge might unfold and what you might do to think about ways to fend that off before they send you the letter okay then next we'll talk about another challenge that does come up frequently and I would say that this one comes up more frequently in the context of aircraft leasing and that's the passive activity loss rules that's IRS Code section four six nine okay so both of these are you know frequently seen challenges and what I'd like to do for the next few minutes is walk you through both of them sounds good please do alright so let's talk about the hobby loss rule first alright and we'll see what kinds of challenges there are and what kind of issues might come up with these what they're saying here is that first of all this challenge will apply to individuals and by virtue of the fact that someone might be involved in what we call pass-through entity that's something like a limited liability company or a subchapter S company or corporation anything where those expenses revenues and expenses might pass through for tax purposes to the individual the hobby loss rule may apply so you have to be prepared for that kind of challenge if you have a regular straight old C Corp you don't have to deal with the Hobby loss channel not a problem huh that's right but if in fact it's a pass-through entity like an S corp or like an LLC then the Hobby loss rule does indeed come into play that's the first thing to note about the Hobby loss rule the second thing is is that what is really at the heart of the Hobby loss rule is the question of whether or not the taxpayer in this case typically an aircraft owner had an actual and honest profit-making objective now how do we ever get to that right we're looking at intent which is always very difficult but that intent you know could be manifest in many different ways for instance if in fact you had a business plan that was drawn up and and that you got some help from professionals like a CPA or from a lawyer to get the business off the ground so to speak then you may have a better case to be made that you did indeed have an actual and honest objective to make a profit I there's also a presumption that if in fact you've generated a profit for three of the last five years and that's kind of our on a rolling basis right so it keeps moving then the IRS by law would typically need to defer to that presumption that in fact you were engaged in the activity with the intent to make a profit there are nine relevant factors because you might say well what's this honest and objective intent there are nine factors that the IRS has generated in the regs that do give us some guidance with respect to whether or not they're going to consider something to be a hobby I'm going to rattle off a couple of these for you not all of them but some of them are obvious some of them maybe not so obvious number one is the activity conducted in a businesslike manner but what does that mean well do you have a separate bank account for the activity do you have a CPA or an accountant who's handling the books creating income statements monitoring the profits and losses of the business what's the profit and loss history for this business there's nothing worse and or nothing more like an invitation for the IRS to come and take a look at your business if all you do is generate one loss after another and and that will indeed attract attention or they want to know often how much time and energy is expended on the activity so the profile of a case that often creates a problem is where somebody has a very high income from their day job and they might be running some kind of side gig with aviation yeah and they are taking large deductions against their ordinary income a year after year you're saying that's right that might you might as well just send them a note to come over and take a look at your records so in fact if that's what's happening you do have to be prepared because they're gonna want to take a little closer look to see if this really is being run in a businesslike way if it really is something where you've got an honest objective to make a profit certainly yeah and let me ask if something is deemed by the IRS to be a hobby are any expenses did in that case the answer is yes okay and a little bit over or generalised but what you will often be permitted to do is to take expenses that get you up to the revenue that you've generated so at the end of the day the IRS would disallow any expenses that are beyond what your revenue was so you'd wind up with a wash often it winds up worse than that but that's the general answer to that question they'll generally allow you expenses up to the revenue that might have been generated interesting thank you all right so that's you know a little bit there about section 183 of the code and the hobby loss rule there are some cases on this that are worth noting the first one there it's an old case but still on the books it's still valid and that was Palo Alto and and in that case as I recall a business was using an aircraft but they were paying for it to be on standby and there was a lot expended on it then the IRS said we'll wait a minute now you're not using it that much why are you paying it to be on standby and after looking at it carefully and once the facts of the case came through during the court case itself in the trial it was determined that in fact there was a reasonable and honest intent to generate a profit the plane did need to be on standby so the IRS ultimately did not prevail in that case the court pushed back on it and the taxpayer was able to take a deduction a one unusual and quite old case which I dug up years ago within a particular instance was this Daugherty case and it surprised me a little bit even when I pulled it up I had a client who was being challenged because there was they had used their airplane a lot in their business and there was one year do do just one thing after another happening and everybody who's an aircraft owner knows how that can happen oh yeah you've got heavy maintenance year maybe an overhaul and this person also had some health issues that year for that year it was hardly used in fact I don't think it was used at all and the IRS was saying see look you've got all these expenses there was no revenue generated we think it's a hobby but back in 45 the Tax Court and it hasn't been challenged since then quite remarkably said look even if you've idled an asset for a particular period of time once it's been placed in service it continues to be placed in service for purposes of business and they did in fact allow the deductions for that idled year especially in case especially depreciation right it is unusual but nonetheless important to note and then finally and this is a more recent case that does have some implications for a lot of our members who own an aircraft and use it for different business enterprises the case is the Morton case it actually came in up in the US Court of claims it basically stands for the fact that if you've got an aircraft and this is not always recommended but in this case the taxpayer had the aircraft and it was a sophisticated jet aircraft so I'll say that in a separate entity and he was using it for a number of other very profitable entities one of them being Hard Rock Cafe and what was going on was that the business enterprise that owned the aircraft was generating nothing but losses because it was getting some revenue from the substantive businesses who were generating profits but by itself it was generating nothing but losses so the IRS looked at that particular aircraft owning antah t and said look this is a hobby it generates losses one year after another what the taxpayer said was no no look this can't be looked at so narrowly you can't just look at that particular aircraft owning company you need to look at the overall unified business enterprise and after looking at the facts the Corps did in fact agree with the taxpayer and said yes we do need to look at Hard Rock Cafe we need to look at your other business enterprises to determine if on a unified Business Enterprise theory we in fact do have an honest and objective intent to make a profit and they did were able to successfully push back on the IRS on that so I think that is an important case as well and we're looking at Hobby losses important indeed and let's put a pin in that one and come back to it because even though the IRS ultimately was you know forced to accept that this was kosher from a tax perspective the FAA might take issue with a single purpose entity where all it does is own and operate an aircraft for compensation so let's circle back to that later you bet we can take a look at that one we're looking at buy/sell issues and your planning as you move forward because there are often intersections between what the IRS is looking for and what the FAA may be looking for so well we will indeed return to that issue the other challenge in fact as you recall what I said at the beginning was we've got the Hobby loss and then another challenge that often comes up in the context of aircraft rental is this passive activity loss PL rule this dates back to 1986 from last tax reform okay and it is you know been holding steady as a rule that the IRS does in fact use and what it basically comes back to and you can't really understand the rule unless you understand the the context that it comes up in what you need to understand first is that when you're looking at income the IRS basically places in come in three different buckets the first one is really ordinary I'll call it the ordinary income bucket and in that ordinary income bucket what normally see are things like your wages salary business income the second bucket that they label everything in that that that can be applicable is the portfolio income bucket they're what you typically see or things like capital gains interest dividends and then finally back in 86 they created a bucket called passive income and that was the first time we'd ever seen it and what that bucket includes is everything else okay and what what so what's important about this well what's important about it is that passive income can only be offset by passive losses and passive losses can only be offset by passive income so it's a separate category all onto itself and here's the key if you're involved in a rental activity there is a presumption under these rules that you are deal if you're involved in the leasing or rental activity there's a presumption that the income is passive and that the losses are passive as well so why is that important because that means if you've got passive losses you can't use those to offset ordinary income right from that bucket or portfolio income income from that bucket you can only use the passive losses to offset passive income so that's in fact why this is so critical and why many aircraft owners have fallen into the trap if they're unwary so the idea is to be aware of it indeed and how might one overcome the presumption that this is passive not easy and I've talked to people about this I've written about it and there are tax advisers out there who don't necessarily agree with me but the case law tends to bear it out that this is not an easy presumption to overcome so because of this presumption you have to take a look at well how do we get out from under this if we can write there are certain exceptions in this slide that's up now you can see one of them says well the average period of customer uses seven days or less or if you can show that the aircraft is only allowed to be used by customers during defined business hours or you say well the average customer use of the aircraft is thirty days or less and you provide significant services you might look at that and say well that's easy if I'm leasing my aircraft typically through an FB or flight school well it's being used on an hourly basis right so this should be an easy test to pass it feels like there's a but coming you're right you read my mind but here's the but the but is if you take a look carefully at those regs they talk about customer use and the problem is that when this has come up before the courts the question comes up who's your customer so if you're an aircraft owner is your customer the FBO or flight school that is leasing the aircraft perhaps from you or is the customer the set of pilots or the group of pilots who any given month or year are actually leasing the plane so who are they a customer of and so the next slide takes a look at some of the cases where this issue has been addressed and as I say right up front there so far no luck in these cases there hasn't been any success in getting past that presumption the first to Frank and Kelly dealt with the issue of an FBO or flight school and what the court said not surprisingly in both of those cases was look aircraft owner you've got a lease with the flight school or with the FBO they are your customer and they're getting the use of the aircraft and I think in both of these leases it was a one-year lease right so all of those exceptions just went right out the window in the Williams case it was a little bit more of a matter of dealing with maybe less than perfect documentation there they were looking at a test that we're about to look at material participation but so they couldn't even get past that test so they never did get to these exceptions to the rental rule so really all I can say with some certainty is that so far we haven't seen any success getting past the presumption that the typical aircraft rental activity is going to be looked upon as a passive activity now if we want to be optimistic and we say well maybe we can get past that if we can get past it the next hurdle that the aircraft owner would have to get past is actually going to be what we call a material participation test and so you're first of all going to have to show that you can get past the rental presumption and you could do that maybe through one of those exceptions so far nobody's been fortunate enough to get past there now you're gonna have to show that you materially participate these are the tests up on this slide that would get you past material participation one of them is the 500-hour test and I'll tell you if you've got a full time job good luck I'm not sure how you're gonna make it past this test sounds pretty difficult right it would be the next one that is out there is the substantially all test which basically says you're doing substantially all of the work and if it's the typical leaseback arrangement and you've got a full time job I'm not sure how you get past this one either the next one is enticing it's the 100 hour test and it basically says well if you've put in 100 hours into the activity that is a reasonable number right but here's the kicker your hours need to be more than anybody else's hours interesting and that could include all the hours that the FBO or flight school is putting into the aircraft then you might be able to argue that you've materially participated in the activity how do you show your participation you need to be able to show in fact that what you're doing is not the kinds of things that a typical owner would do in other words poring over the books and records is more of an investment activity so that's probably not going to pass muster anything related to your participation in it as an investor is not going to necessarily count toward any of these tests so what do you need to do you need to if you ever get to this point you need to document very carefully what you're doing you need to be able to show and I would say even though the regs don't require it I would say contemporaneous and detailed documentation on a daily basis or an hourly basis based on what you're doing is gonna be the way to get through this you have to just assume that you're gonna be audited and you have to be comfortable with what you'd be presenting to an auditor at the end of the day for all of these tests well those are some good tips for record-keeping anything else you would add to that as far as making the best case possible um I would say that if you're if you do or if you're fortunate enough to get some material participation test you would want to show also how your activity the hours that you're documenting you know add value to the activity how you've been engaged in this activity with the flight school or with the FBO anything that would tend to establish that would be helpful again no I'd be careful because we really haven't gotten to that point yet we haven't been able to get past that presumption now the good news though is that Eve if the losses are treated as passive not all is lost what's gonna happen is those losses will then be stored up so if you have no passive income and most taxpayers don't but if you don't and you're just storing up these losses you can later on use those passive losses to offset any passive gains which would ordinarily show up when you ultimately sell your aircraft and we'll actually talk about that in the next segment when we get to buy sell considerations alright ray thanks for talking us through all of that we'll be right back with you after a short break that talks about the legal benefits available under AOPA pilot protection services remember you can reach us during business hours on the East Coast 800 us AOPA through the legal services plan thanks we'll be right back with you I was going to use the plane for business purposes when I was dealing with pilot protection services and I knew I had an attorney on the phone it was one thing but when I knew I had an attorney and a CPA it was another thing the gentleman walked me through the legalities and the accounting ramifications of all three types of companies that this airplane would be in whether it was private in my company earning a new LLC welcome back from the break thanks for staying with us next up we'll be talking about considerations related to buy sell transactions with aircraft and Ray walk us through that if you would please beginning with recapture sure it's not an exhaustive list of things I've got but I didn't want to go over the things that we most often encounter for our members when they're looking to buy or sell an aircraft and one of the first things that often comes up especially in the context of the sale of an aircraft that's been used for business purpose is depreciation recapture so I wanted to go over a quick example with you that hopefully will illustrate a simple example maybe a bit oversimplified but hopefully it'll hit the mark in terms of just explaining what this concept is all about and so suppose you've purchased an aircraft for $500,000 you've been using it for business let's just assume a hundred percent for business over the years and after six seven years it's been fully depreciated at that point what you have to understand is every year that you generate depreciation expenditures you're reducing what we call the tax basis of that aircraft so if in fact you and this is maybe a bad assumption but for purposes of our illustration you haven't added anything new to the aircraft no new avionics nothing like that what's gonna happen is if you've depreciated it fully now the tax basis of that aircraft has gone from five hundred thousand dollars - five hundred thousand dollars worth of depreciation your tax basis is now zero so let's just say that now you find a buyer and the buyer is willing to pay $400,000 what you now have is a $400,000 game okay and that $400,000 gain is considered to be an ordinary game why is that important because that means that that gain be taxed at ordinary tax rates just like business income just like your salary just like any other typical kind of income that you might have so that's the basics of what we call depreciation recapture and that could come as a surprise to someone who said hey I bought it for five hundred thousand dollars sold it for four I just lost a hundred thousand dollars that might be what's in their mind but that's not what the IRS is thinking what they're thinking is you've been able to expense that aircraft you've been able to gain the benefit of that depreciation deduction over these years and what they give us they take us at the end of the deal through this what we call depreciation recapture right and if you could tell us when might you have a capital gain on an aircraft sale instead of it being the other category sure we rarely see this but it could happen if for instance we use the example I just gave you and where you purchase the aircraft with five hundred thousand you depreciated it down to zero you could have a capital gain if in fact let's say you sold it for six hundred thousand dollars then what would happen is you'd have a $100,000 capital gain which is essentially the difference between what you purchased it for the five hundred thousand and the six hundred thousand and then everything else would be considered an ordinary gain of five hundred thousand dollars and why is it important that part of that would be classified as a capital gain because with the capital gain you would gain a benefit with respect to lessor rates okay instead of the ordinary rates you'd be able to pay on the capital gain rate which would be significantly less than your ordinary rates in most cases so that's that's when it might happen understood thank you right and we're ready to move on to like-kind exchanges that's right although they don't exist anymore we'll move on to them but it's worth it's worth discussing it anyway because this was really an important an important piece of the new legislation that just came up into south and it really did raise a lot of concerns as the discussion was going on as the sausage was being made so to speak we were seeing that the the legislative folks and in Congress were in fact looking hard at this section which is called like-kind exchange and what like-kind exchange is allowed people to do for as long as I can remember and that's a long time is they allowed folks who for instance had that $500,000 airplane that they were using for business exchanged them for another aircraft which would typically be a little bit more expensive and they'd be able to defer all of that ordinary recapture gain so it was a great help to businesses of all kinds not just aviation but during the course of the new law like-kind exchanges with respect to tangible personal property which is what an airplane is that they were eliminated so you no longer can use a section 1031 exchange with respect to aircraft okay or any other kind of tangible personal property they didn't just single out aircraft you got real estate still good but not for an airplane and that did really raised a lot of concerns and and then the course of that organizations like AOPA and others God and said we've got to do something because this could really hurt the aircraft business both new and used and so what did come about which is very helpful and we'll talk about it we did actually talk about it a bit earlier was this bonus depreciation provision so let's just say that you were in the circumstance of that aircraft owner who fully depreciated the five hundred thousand dollar aircraft and now you got a zero basis and you sold it for four hundred thousand dollars well let's just say that that same owner now upgrades to a six hundred thousand dollar aircraft if indeed they're able to take advantage of the bonus depreciation provisions they would be able to then take a full six hundred thousand dollar deduction which would offset the four hundred thousand dollar recapture gain that they had from the previous transaction where they sold it it actually to some degree simplifies things because this is a lot easier to deal with in a 1031 exchange there was sort of a an industry of qualified intermediaries that was needed to essentially move along a 1031 exchange but now you've got a little simpler the economy but the issue here is again that those bonus depreciation provisions are temporary as I noted in the earlier slide they do start to fade away over the years so we're not sure how this is going to come out the other end but for now they're in place and they are helpful one other uncertainty that's worth noting is while we're pretty sure that this for many aircraft owners are used their aircraft exclusively for business this bonus depreciation may be helpful what we're not so sure about is how this is going to be dealt with at the state level most states have and we use the word decoupled they've decoupled from the federal depreciation schedule so many states may not allow this kind of bonus depreciation so you may still be stuck with and you may still get hit with the recapture gains at the state level but not the federal level this will keep many accountants busy for years to come but it is in fact just the way things are right now and we've or we've already had to deal with the fact for many years that state laws do not coincide exactly with the federal laws especially when it comes - depreciation schedules yeah big changes it sounds like there are and we're not even sure exactly how all of this is going to flush out regulations are going to be following overtime cases will be following so we'll keep our eye on that for everybody and try to keep you up to date as we see anything that would be important it sounds good thank you Ray all right another issue that does come up and this is addressed in the next slide is and this is to some degree relevant to our membership we do see it from time to time although it's a little bit rarer than the business owner we do sometimes see employees who are using an aircraft in support or in furtherance of their employers business that's now going to run into a new set of issues and the new set of issues are essentially initiated because the new law that came out in December essentially repeals the deduction for unreimbursed employee business expenses it it got there because what they did was they eliminated all miscellaneous itemized deductions so they weren't just focused on employee employees who used their hair crafts for business purposes it was a much broader repeal the reason why it didn't come up a lot was because in order to be deductible in the first place the employees unreimbursed expenses would need to exceed 2% of their adjusted gross income so in other words if you had an employee who had $100,000 of adjusted gross income you couldn't even get to deduct any aircraft expenses until they got past $2,000 so it did eliminate a lot of the deductions initially anyway so we didn't see a lot of it how can you deal with this if you're an employee and you do use your aircraft you're your employer authorizes you'd use it the best approach based on everything I've seen so far and we're going to you know be following that is probably to try to work out with your employer to get what's essentially called an accountable plan arrangement an accountable plan arrangement is where you need to as an employee substantiate your expenses you know you submit receipts your employer then would reimburse you if you've got any advances you'd have to pay back whatever you didn't use and there's a long trail of documentation with those accountable plans so if your employer is willing to work something like that out with you you may still have a shot at it all right very good advice there Ray and next let's move on to one of our most popular questions that we get through the legal services plan which is if I'm buying an aircraft should I buy it through an entity and if so what kind right and that does often come up in in multiple contexts this is clearly one of those circumstances where whenever I get this question I generally want to talk to the members CPA or lawyer or tax advisor because it's not so easy a question to answer without understanding the fuller context of that person's tax circumstance and and that really goes for just about everything we've said you can't just look at this these kinds of questions for aircraft in isolation from everything else members sometimes get a little annoyed when I say well I would like to talk to your CPA about this well why this is the airplane issue well it's because the decisions we make related to the aircraft could have consequences with respect to all your other tax activity so we do want to look at the holistic picture so should the aircraft be placed in a separate entity sometimes that's a valid or a viable option sometimes it's not I'll often look at this question and ask the member well are you how much are you gonna use the airplane well I'm going to use a 90% for for business well does the business as the business been profitable I'm assuming the answer is yes have been you've been in the business for many years well why not just put the aircraft in the business oh because I want to try to avoid liability well I got to tell you this the good and the bad news is you're really not adding to your liability exposure by placing it directly in the business and having the business on it because whenever you use it for business purposes your business is exposed to liability so often it is a question of whether or not it ought to just be bought right into the business itself and and that typically makes the most sense I've seen lots of different approaches but that's one that I do like to use when it's available some owners do have multiple business enterprises and Chad this goes back to what you and I were talking about a little bit earlier where they want to keep the airplane in a separate entity and then perhaps lease it out to their various enterprises sometimes they don't even want to do a lease but they probably should and and that that's where you start to talk about FAA issues right and where the FAA has looked at aircraft that are placed in an LLC that does nothing but own an aircraft and they might look at that and say hey is that a flight department right there are a couple of interpretations we've seen that would lead us to believe that that's a possibility so how do you deal with that well again you need to talk to advisors we would be happy to talk to advisors and see if there's a way to make that work through try leasing arrangements to the various entities that are out there and sometimes it still works better if you put it in the one business entity that'll use it most often and then that business entity might lease it to the ancillary business entity that makes sense and that can work from both a tax perspective and an FAA perspective another issue that's really non-text that sometimes comes up in this context is will you be flying employees around right and there are some FAA issues there but there's also some insurance issues there what you'll see in most business and pleasure policies is a provision that says if employees are subject to workers comp they may not be claims against this policy are not going to be covered and then you might look at the workers comp policy and it may say something like we don't cover aviation activities so that's a real catch-22 there it could be so as you're planning on using an aircraft you know beyond the tax considerations you'll also want to look at insurance issues as well to make sure that this is fully dealt with prior to any kind of purchase so there are no nasty surprises yeah that could be quite a surprise if you're not careful and looking out ahead of time that all right right do you have any additional thoughts you want to add maybe could you talk us through what sort of benefits are available through pilot protection services and the legal services plan related to aircraft tax issues sure and this one's sort of near and dear in my heart because way back when and right around 1990 or so that ages me but we set up this benefit through the plan and primarily the benefit itself was designed to cover circumstances where your tax return might be under audit and you're an appealing and audit decision to either IRS appeals or to the Tax Court and we would get you out to local counsel who could help you along with that appeal the basically the Appeals conference or the Tax Court case in order to be covered you'd normally need to have filed the tax return while you were a member of the plan but we've really been more than happy to talk to members who haven't been yet subject to an audit and who were thinking about what they want to do with their aircraft they're doing their planning and we're generally pleased to have them call in we'll talk to you often will prompt you to talk to your CPA or tax advisor so we can feel comfortable and they can feel comfortable that this is being set up properly and that's been really one of the side benefits to being a member of the plan yes indeed alright well thanks for explaining all that so eloquently ray let's go ahead and wrap it up we'll give you our contact information remember you can reach us 8:30 a.m. to 6 p.m. Eastern Time here at the legal services plan 800 us AOPA or 301 six nine five twenty four hundred you can subscribe to this youtube channel for the latest content thanks again for watching and have a good evening everyone you

Channel: AOPA | Your Freedom to Fly

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Keywords: aopa, airplanes, aircraft, aviation, aviation videos, airport, pilot, flight, flying, vfr, ifr, general aviation, general aviation videos, flight training, tax, taxes

Id: Wou352Nrek8

Length: 61min 27sec (3687 seconds)

Published: Tue Feb 13 2018