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TAX CASE EXPANDS AIRCRAFT MAINTENANCE DEDUCTIONS

DEFINITION OF AIRCRAFT REPAIR EXPANDED

Both new and used aircraft have very substantial tax savings available through rapid depreciation. However, if an expenditure can be properly classified as a repair, the write off is immediate and it will not result in depreciation recapture upon sale. A tax case, FedEx Corporation v. U.S., 95AFTR 2d 2005-1105, provides that significant improvements to a used aircraft may be expensed currently.

CAUTION – THE IRS MAY NOT AGREE WITH THE FEDEX CASE

This case originated in the U.S. District Court of Tennessee and was affirmed by the U.S. Court of Appeals in the Sixth Circuit. Like all cases, it is fact sensitive and should be carefully reviewed. In addition, the Service may choose to litigate additional cases that would be appealed to other circuits of the U.S. Court of Appeals. Although the Internal Revenue Service has not made an announcement subsequent to the FedEx case, they previously issued Revenue Ruling 2001-44, which would seemingly result in a more restrictive case for expensing.

WHAT ARE REPAIRS, AND WHAT MUST BE CAPITALIZED?

The issue in the FedEx case involves whether or not engine shop visits, (inspections including hot sections and overhauls), need to be capitalized or could currently be expensed. In reviewing the facts, the court referred to the IRS repair regulations which allow taxpayers to deduct the cost of “incidental repairs” which do not (1) materially add to the value of the property, (2) appreciably prolong the life of the property, or (3) adapt the property to a new or different use.

The first issue before the court is what is incidental? Incidental was found not to carry independent materiality, but is measured only as a description of those improvements that do not increase the value of a specified unit of property, prolong its life, or adapt it to a new use. They therefore found that costs were incidental even though, in some cases, these costs exceeded $1,000,000.

The second issue relates to what is the property? Is it the whole aircraft or just the engines and the APUs? The court looked at three tests to conclude that the whole aircraft was the property. These tests of what is the property include, as a matter of industry practice, engines are generally purchased with an aircraft; the engine is expected to last as long as the aircraft itself; and the aircraft cannot function independently without the engine. Therefore, when determining both value and extension of life, we look to the aircraft as a whole.

A third important issue related to the time of valuation is determining what is a material addition to the value of the property? The court concluded that you do not measure the value immediately before and after an overhaul, but you compare the value after the overhaul with the value immediately after the previous overhaul. The court recognized that over time the aircraft will decrease in value.

Finally, the court looked at the value of the repair compared to the value of the entire aircraft as a whole. They held that all expenses for the engine and APU overhauls were deductible expenses.

WHAT ELSE COULD BE EXPENSED BEYOND ENGINE OVERHAULS?

If an aircraft owner can position themselves similarly to the facts in FedEx, the case could also support the immediate write off of items such as:

1. Paint
2. New interior
3. Compliance with airworthiness directives / service bulletins
4. RVSM costs
5. TAWS costs
6. All other airframe repair

HOW TO MAXIMIZE SAVINGS ON USED AIRCRAFT PURCHASES

A used aircraft purchaser should consider the following:

1. An aircraft with nearly “run-out” engines may result in ordinary deductions for the cost of rehabilitation. If the seller overhauls the engines they will be capitalized and depreciated, but the buyer may generate an immediate write off.

2. New paint and interior may result in deductible cost to the purchaser provided he pays the cost, and will be depreciable if the seller pays for it.

3. Squawks that are remediated by the purchaser will normally result in fully deductible expenses. If they are paid for by the seller their cost will be included in the capital cost of the aircraft.

A used aircraft purchaser should be encouraged to place the aircraft into service before incurring the expense. In the FedEx case, the taxpayer did not attempt to write off expenses prior to the aircraft being placed into service.

The benefits potentially resulting from this case could be substantial for qualified taxpayers. Finally, taxpayers are cautioned when relying on a single case, particularly outside the jurisdiction of the circuit and to the extent it is contrary to a published ruling. You are therefore encouraged to talk with your tax advisor prior to positioning yourself for a deduction.