The Tax Court recently held that an operational aircraft delivered and titled to a taxpayer late in December 2003 was not “placed in service” in 2003. Accordingly, the court rejected the taxpayer’s claim of a bonus depreciation allowance for 2003.
The court’s decision hinged on whether the aircraft was available for its “specifically assigned function.” Evidence presented at trial indicated that the taxpayer had particular needs for the aircraft, including a conference table and enlarged computer screens. Because those modifications were not made until early 2004, the Tax Court agreed with the IRS position that bonus depreciation was allowable only for tax year 2004. In both years, the bonus depreciation allowance was 50% of the adjusted basis for qualified property.
The sole substantive issue was whether Michael D. Brown was entitled to claim the 2003 deduction of more than $11 million in bonus depreciation on the Bombardier Challenger jet he took ownership of on Dec. 30, 2003.
The Tax Court described Brown as “an insurance genius” who sold only supersized life insurance policies to very high-net-worth clients. On larger policies he sometimes earned more than $10 million in commissions. Due to client demands, aircraft availability was an important ingredient to Brown’s success.
The IRS did not question Brown’s use of an aircraft as an insurance salesman. However, it did focus on Regs. Sec. 1.167(a)-11(e)(1)(i) when evaluating his claim for the $11.2 million bonus depreciation allowance for 2003. The regulation states that “[p]roperty is first placed in service when first placed in a condition or state of readiness and availability for a specifically assigned function” (emphasis added).
The Tax Court zeroed in on the “specifically assigned function” language, based on Brown’s testimony. Brown testified that the aircraft as delivered on Dec. 30, 2003, “was complete in every way except for [the conference table and enlarged viewing screens] that [he] needed.” Brown made arrangements for those modifications, totaling a bit more than $500,000, to be made in early January 2004. The court opined that it is the taxpayer “who gets to determine what an asset’s ‘specifically assigned function’ is.” At trial, Brown argued that the jet was fully functional for his purpose of business travel when he took possession of it and that his modifications merely made it more comfortable for conducting business. The court, however, noted that his testimony also indicated he considered the modifications to be “needed” and “required.”
In determining that the additional modifications required by Brown meant that the aircraft was not placed in service in 2003, the Tax Court relied substantially on Noell, 66 T.C. 718 (1976); Consumers Power Co., 89 T.C. 710 (1987); and Valley Natural Fuels, T.C. Memo. 1991-341, aff’d, 990 F.2d 1266 (9th Cir. 1993). All of these cases held that an asset needs to be available for its specifically assigned function to be considered placed in service.
The court noted that an asset does not need to be used before it is regarded as being placed in service. However, the Tax Court cautioned that this does not necessarily mean that because an asset is used in a certain year, it has also been placed in service for that year. The day he took possession of the jet on Dec. 30, 2003, Brown flew from Portland, Ore., to Seattle to meet a client and then to Chicago, where he met with another insurance agent, before returning to Portland, an approximately 4,000-mile round trip.
While the court’s decision addresses the placed-in-service issue in the context of an airplane, its significance is readily transferable to any asset where a placed-in-service date is in question. The decision does raise the question of when a taxpayer crosses the line with enhancements or modifications to an asset. In this case, modifications acknowledged by the Tax Court to be “seemingly minor touches” costing a little over $500,000 were made on an aircraft with a $22 million price tag. Should upgrades valued at roughly 2% of an operational asset’s value render it substantially unavailable for its specifically assigned function? Also, are there unintended consequences when the court turns to a subjective test by relying on the taxpayer’s determination of a specifically assigned function? These questions may be addressed if this decision is appealed.
By Raymond C. Speciale, Esq., CPA, associate
professor of accounting and law, Mount St. Mary’s University,
Emmitsburg, Md., and Ronald D. Golden, Esq.,
counsel to Aircraft Owners and Pilots Association.