Aircraft Depreciation – Everything You Need To KnowJanuary 23, 2020
When a business purchases an airplane or a helicopter, it can use aircraft depreciation to recover the aircraft’s cost. In this article, we’ll introduce the topic of depreciation in general and aircraft depreciation in particular. After explaining how airplane depreciation works, we’ll explore the use of an aircraft depreciation schedule and airplane bonus depreciation. Naturally, these topics depend on airplane depreciation life. Therefore, it’s important to distinguish airplane depreciation for the IRS from airplane depreciation for GAAP. Also, we’ll explain Section 179 rules and bonus depreciation for an airplane. Finally, we’ll finish up by answering a few frequently asked questions about aircraft depreciation.
Video: Does Bonus Depreciation Apply to Used Aircraft Purchases?
Aircraft Depreciation Rules
To understand aircraft depreciation rules, we must first explain the basics of depreciation, both IRS and GAAP. We’ll start with types of depreciation.
Types of Depreciation
When businesses spend capital on long-term assets such as airplanes, helicopters, buildings, factories, and machines, they know that the asset’s value will decline as time goes by. Depreciation is a procedure for subtracting the reduced value during an asset’s usable life. Annually, you record the amount of depreciation by making journal entries. Specifically, these debit the Depreciation Expense account and credit Accumulated Depreciation, a contra-asset that diminishes the asset’s book value. Naturally, you keep on booking depreciation annually until the book value of the asset falls to the asset’s salvage value.
Depreciation involves these terms:
- Cost: How much you pay to obtain the asset.
- Salvage Value: The projected asset value you might realize if you trade-in, scrap, or sell the asset. It follows full depreciation minus any disposal expenses.
- Recovery Period: An asset’s useful lifetime.
- Obsolescence: Something that reduces an asset’s depreciation period. For instance, an asset with an operating lifetime of 10 years, but that will actually be obsolete in six years, has a six-year GAAP recovery period. Importantly, MACRS depreciation ignores obsolescence.
Several methods exist to apportion depreciation throughout an asset’s useful lifetime. Of course, the straight-line procedure remains the most common and simplest. Also, there are a few accelerated depreciation mechanisms that provide businesses with larger deductions early on. This reduces taxes and income in the early years, which then increase in the asset’s later years.
You recoup the initial cost via tax deductions over the recovery period:
- Modified Accelerated Cost Recovery System (MACRS): The method you use for airplane depreciation for the IRS. It specifies depreciation periods for all asset types, from as little as three (3) years to thirty (30) years and greater.
- Generally Accepted Accounting Principles (GAAP): The period of recovery that businesses use for financial reporting. GAAP governs the format and content of balance sheets, income statements, and other financial reports. Note that the asset’s actual useable lifetime acts as the recovery period.
Annually, you must resolve the conflicts between your MACRS and GAAP depreciation results to ensure correct tax payments.
All depreciation methods share these steps:
- Ascertain annual depreciation using any of the procedures specified below.
- Book the annual depreciation amount. You record a credit to Accumulated Depreciation and a debit to Depreciation Expense.
- You stop depreciating when the initial cost, less accumulated depreciation, falls to salvage value (or to zero for methods that don’t use salvage value).
Straight-line depreciation is the simplest and most common. It works like this:
- Find the period of recovery. For MACRS, look it up in the tables provided by the IRS.
- Book the year’s depreciation, which is ((book value – salvage value) / recovery period).
Example of Straight-Line Method
Imagine you purchase an aircraft for $45 million and assume a $5 million salvage value in 10 years. Therefore, the GAAP depreciation amount is calculated as follows: ($45 million – $5 million) / 10 years = $4 million/year. Obviously, that equals an annual depreciation percentage of 1/10, or 10%. Annually, you credit Accumulated Depreciation and debit Depreciation Expense for $4 million.
Double-Declining Balance Method
This is an accelerated depreciation process. It gives larger depreciation figures at the beginning. Then, the depreciation figures decrease as time goes by.
- Use the double-declining balance depreciation rate, which is double that of the straight-line depreciation rate.
- Record annual depreciation. It equals starting net book value x depreciation rate.
- Repeat till the book value falls to the salvage amount.
Example of Double-Declining Balance Method
Start by doubling the straight-line percentage. Pertaining to our example, you have 2 x 10%, or 20%. Multiply this percentage for Year-1 by the initial cost (disregarding salvage value): 20% x $45 million = $9 million. This is the Year-1 Depreciation Expense, decreasing book value to $36 million. Year-2 depreciation is 20% x $36 million or $7.2 million, diminishing book-value to ($36 million – $7.2 million), or $28.8 million. Repeat until the value falls to the $5 million salvage value.
Sum-of-Years’ Digit’s Method
Usually, this procedure is not as aggressive as double-declining depreciation. Be aware that the sum-of-years’ digit’s method disregards net book value.
- Sum up the digits using (n2 + n)/2 where the period of recovery is n.
- Calculate the depreciable figure, which is equal to initial cost minus salvage value.
- Form the yearly factors by dividing the digits’ sum into the years remaining. For instance, the Year 1 factor is (10/55), the Year-2 factor is (9/55), etc.
- Record annual depreciation, equal to annual factor x depreciable amount.
Example of Sum-of-Years’ Digit’s Method
Returning to our example aircraft, let’s say that the GAAP period of recovery is 10 years. Therefore, sum the following digits: 1 + 2 + 3 + … + 10, which equals 55. Or instead, use the calculation s = (n2 + n)/2, which equals (102 + 10) / 2. Remember that $40 million is the amount depreciated. For Year-1, the depreciation amount is (10 / 55 x $40 million) or $7.3 million. Next, compute the Year-2 deduction by subtracting the Year-1 depreciation from the amount depreciated ($40 million – $7.3 million), or $32.7 million. Next, multiply the difference by 9/55, to get the Year-2 depreciation of $5.4 million. Continue for the following years until the you reach zero.
A business can select its depreciation method. Theoretically, it should choose the procedure that most directly reflects the asset’s real-life value loss. The depreciation method must always be systematic and rational. The straight-line method is most appropriate for assets that exhaust value at an even rate. Different assets that exhaust value quicker during the early period favor a depreciation procedure that’s accelerated. However, businesses frequently utilize the aggressive procedures because they gives the largest tax deductions early on.
Video: What Schedule Do I Use to Depreciate My Aircraft?
Airplane Depreciation Schedule
The MACRS aircraft depreciation schedule for Part 91 business aircraft is five years. However, if you use the aircraft to transport freight or passengers, the MACRS recovery period is seven years.
Aircraft Depreciation Calculator
You can quickly compute depreciation by using the aircraft depreciation calculator at this web page. This calculator is free and adheres to the MACRS rules. You have to enter the airplane depreciation life to use the calculator.
Section 179 Expensing
Section 179 is a special tax provision. It allows businesses to deduct certain capital assets as an expense in the current year instead of multi-year depreciation. Aircraft qualify for Section 179 treatment. You claim Section 179 expensing on IRS Form 4562.
For 2020, you can get the Section 179 deduction on up to $1 million in asset purchases. However, if you make more than $2.5 million in asset purchases in 2020, your deduction will begin to decline. Specifically, your deduction falls by $1 for each dollar above $2.5 million you spend on qualifying property. For example, if you buy $3 million of qualifying property, your Section 179 deduction will fall to $500,000.
In addition, your net income caps your Section 179 deduction. Obviously, you can’t deduct more money than you earned.
For 2020, bonus depreciation for an airplane is 100%. Specifically, you can deduct 100% of the cost of qualifying assets you purchase in 2020. This bonus depreciation has no dollar cap nor net income requirement. However, you must use the aircraft at least 50% for business.
Frequently Asked Questions
Why is the tax depreciation accelerated on aircraft?
You use accelerated depreciation on aircraft to recover your costs faster. You want to depreciate your assets as quickly as possible so that you can use the tax savings sooner.
Should I depreciate my aircraft?
Most assuredly, if you can. You can only depreciate aircraft if you use it for business. For bonus depreciation, you must use the aircraft at least 50% for business. You cannot depreciate aircraft purchased for personal use that doesn’t relate to business.
What happens when I sell a depreciated airplane?
Any depreciation you claimed reduces the airplane’s cost basis, giving you the adjusted cost basis. Profit is sale proceeds minus adjusted cost basis. You treat as ordinary income any profit you earn on the sale of a depreciated airplane. Indeed, you cannot claim the profit as a capital gain.
What expenses can you deduct for a business jet?
You can deduct all expenses required to operate and maintain the business jet. This includes regular maintenance, repairs, insurance, licenses and permits, fuel costs, crew costs, and, of course, depreciation.