Tax reform and the rational aircraft buyer and seller
In the following article, aviation lawyer Stewart Lapayowker (pictured below) asks: “Tax reform proposals may be having an effect on the decision-making of aircraft buyers and sellers, but should they?” The article first appeared in the Q4 2017 edition of his newsletter The Fly Paper.
The tax reform proposals of both the House and Senate provide for reductions in corporate tax rates to 20% (the Senate provision would defer the reduction to 1 January 2019). The House would reduce tax rates for pass-through entities to 25% starting in 2018, and the Senate proposal would allow a deduction of 17.4% of domestic qualified business income (subject to limitations) to address pass-throughs.
Instead of five-year MACRs depreciation (for Part 91 aircraft) and 50% bonus depreciation for new aircraft placed in service, the House proposal would allow 100% expensing of new and PRE-OWNED aircraft, retroactive to 27 September 2017. The Senate proposal would merely increase bonus depreciation to 100% retroactive to 27 September 2017.
For those buying smaller aircraft, the 179 deduction (currently $500,000) would increase to $5,000,000 under the House proposal and $1,000,000 under the Senate proposal.
In both proposals, there would be limitations on interest deductions, and an elimination of 1031 tax deferred exchanges for personal property (which includes aircraft). If one were to be able to expense 100% of an aircraft, a 1031 would not likely be needed since, if you replaced the aircraft that you sold with a replacement aircraft in the same tax year, the deduction for the new aircraft would likely offset the gain on the sale of the relinquished aircraft.
How should a rational Seller respond to the proposed tax changes?
A Seller woould presumably look at the tax impact of the sale. Since tax rates for corporations or pass-through entities would decrease in 2018, presumably a Seller may think about postpoining the sale of the aircraft until 2018. But practically, when a Seller has its aircraft for sale, it’s for a reason and I have to doubt that a Seller will push off a qualified Buyer just to consummate the sale next year. It’s possible, but not necessarily rational, given that buyers have other inventory in the market to target.
Should a rational Buyer defer a purchase until 2018?
The answer is probably not. For new aircraft, a Buyer already will receive 50% bonus depreciation, so the House and Senate Bills will only improve a Buyer’s position to 100% and, if passed, the expensing or increased bonus depreciation would be retroactive to 27 September 2017, so there is no rational reason for a Buyer of a new aircraft to wait until 2018.
What about pre-owned aircraft? In that case, there’s a definite difference between the House and Senate models (the House allowing for 100% expensing), but it should make no difference to the Buyer of a pre-owned aircraft since the House provision would be retroactive to 27 September 2017. That is, the pre-owned Buyer either benefits from buying a pre-owned aircraft before 2017 year-end (if the House model is adopted) or it doesn’t if the Senate model is adopted (and things stay status quo). Holding off and waiting would not seem to be rational.
If the 179 deduction were the only benefit available to a small aircraft buyer, then it would be rational for Buyers of smaller aircraft to “wait and see” because there is a significant difference between the $5 million House 179 deduction and the $1 million Senate 179 deduction (179 would apply to new and pre-owned). But those same buyers have available to them the other cost recovery provisions mentioned above. Betting on how the 179 deduction will come out does not seem to be rational, except perhaps in the case of pre-owned lower priced aircraft.
The decision-making of a rational Buyer of a new or pre-owned large aircraft should not be affected by the tax reform proposals, and a Seller who has committed to sell its aircraft would ordinarily not push off a qualified buyer.
If everyone behaves rationally, Q4 2017 should be business as usual. But who says everyone is rational?