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As we have been rushing through this end of year madness there has been a new sense of urgency due to the scheduled phasedown of bonus depreciation. To be clear, bonus depreciation is not ending on January 1, 2023. There is a scheduled phasedown that was included in the Tax Cuts and Jobs Act of 2017 (“TCJA”). Throughout the history of bonus depreciation we have seen various legislation that has increased, decreased, extended and/or phased-out bonus depreciation.  As it stands now, below is a summary of the scheduled phasedown of bonus depreciation pursuant to the TCJA:

In addition to the percentages shown above, there is a one-year delay in the phasedown percentage for Certain Aircraft and Transportation Property. Certain Aircraft and Transportation Property are both defined in the TCJA. As a result, many aircraft transactions in 2023 will still be eligible for 100% bonus depreciation. In the alternative, the worst-case scenario for 2023, is that if an aircraft does not meet the definition of Certain Aircraft and/or Transportation Property, then the bonus depreciation amount available will be 80%.

As has always been the case, just because an aircraft purchased by a buyer is eligible for bonus depreciation, that does not mean that the buyer automatically qualifies to take the bonus depreciation. The intended use of the aircraft (business vs. personal; within the United States or outside of the United States) and the specific tax situation of the buyer will need to be closely reviewed to determine eligibility to take bonus depreciation.

It is important to always remember that a key step when purchasing an aircraft is the development and implementation of an aircraft ownership and operating structure and tax plan, both at the federal level and state level, which should be in place prior to closing and followed after closing.

 

More often than I would have thought possible, buyers and sellers are motivated by a variety of reasons to close on the purchase and sale of a pre-owned aircraft before the aircraft meets the delivery conditions specified in the aircraft purchase agreement (whether before the inspection has been completed and/or before the inspection discrepancies have been rectified). Sometimes it is because the buyer wants to close to start a major refurbishment to the aircraft and it would be more efficient to fix the discrepancies simultaneously with the refurbishment. Other times the seller wants the aircraft sold by a specific date for financial reasons, to make room for their newly acquired aircraft, or so the seller’s crew can leave for training on a replacement aircraft. Currently the most common reason is because of supply chain issues, such as when a particular part cannot be found, and it is a part that is not required to return the aircraft to service. Regardless of the reason, closing before the aircraft is in the delivery condition is becoming more common.

If the inspection is not complete at the time of closing, the risk to the buyer may be substantial because there could be unknown issues with the aircraft. Additionally, if closing takes place while the discrepancies are in the process of being repaired then additional, significant discrepancies could be found, but the buyer may not have any recourse.

If the parties understand the risks and elect to move forward and close before the aircraft is in the contractually agreed-upon delivery condition, there are two options. The parties can agree on a purchase price reduction based on the estimated cost to repair the discrepancies or the parties can agree on a holdback amount to be held by the escrow agent after closing, with the holdback used to pay for the repair the outstanding discrepancies.

A reduction in purchase price allows the parties to complete the transaction and have no further dealings with one another. The price reduction amount should be the estimated amount to correct the outstanding discrepancies plus an amount that represents the risk that the buyer is assuming by accepting an aircraft before it meets the delivery conditions. A short amendment is needed to document that the buyer is accepting the aircraft even though it does not meet the delivery conditions in exchange for the price reduction. The amount of risk being assumed under this option depends on the status of the inspection and/or the extent of the unrepaired discrepancies. One understated benefit of the price reduction over a holdback is that the transaction is completed, thus the seller has no further responsibilities, and the buyer is free to do whatever they want with the aircraft going forward.

Alternatively, a holdback allows the seller to remain responsible after closing for paying the cost of the repairs necessary for the aircraft to meet the delivery conditions and has less risk for the buyer. In this case, the buyer and seller must continue to interact until the repairs are completed and the holdback is released from escrow. The business terms in the holdback amendment may vary but should include all the following:

1. The amount of the holdback. This can be the estimated repair amount or a greater amount depending on the specific repairs needed.

2. Precisely what the holdback can be used for. Can the holdback only be used for the repair of the specifically identified discrepancies or for any other discrepancies found while the repairs are being completed.

3. A clear understanding of which party is responsible for any shortfall if the holdback is not enough to cover the repairs.

4. The process of how the holdback is released from escrow- irrevocable escrow instructions to release the holdback when the final invoice is submitted for the repairs or by mutual consent of both parties.

5. A deadline for how long the holdback can remain in escrow.

6. The escrow agent should be a party to the holdback amendment, and they should confirm they understand the terms prior to execution.

There can be legitimate business reasons to close on a pre-owned aircraft prior to the aircraft meeting the delivery conditions as originally agreed upon between the parties. When the parties desire an early closing, it is important that the risk allocation is considered in the financial terms and that the agreement of the parties is clearly documented, including, if necessary, the post-closing obligations of the parties and the responsibilities of the escrow agent.

For nearly two years we have been in the most significant seller’s pre-owned aircraft market in recent memory and the consequences are beginning to surface in various ways.

First, during this unprecedented seller’s market, some buyers, in order to be selected as the winning bidder for a particular aircraft, have skipped full pre-purchase inspections and complete aircraft records reviews the consequences of which are now surfacing.

One consequence we are seeing is that some aircraft which were thought to be charter ready, are not able to be added to Part 135 certificates unless major modifications are done. Not only are these modifications expensive, but supply chain issues and limited openings at maintenance facilities are causing extensive delays. Additionally, when the new aircraft owners take their aircraft into the shop for the first scheduled inspections since closing, the findings are overwhelming. Major corrosion on the aircraft and undisclosed deferred maintenance are just a few of the issues that have come up.

An additional consequence of this seller’s market is that buyers expediated the purchase process, prior to developing an accurate operating budget for the aircraft. As such, buyers did not plan or budget for upcoming major inspections and/or unknown discrepancies. As a result, the cost to own and operate the aircraft exceeds the estimated costs put together during the quick purchase process.

Next, there has been an increase in management company changes during the initial year of aircraft ownership. New buyers who purchased aircraft quickly selected management companies before fully vetting the company to make sure it was a good fit. As a result, aircraft owners are changing management companies at levels I have not seen before. The increase in management company changes is costly to the industry due to the time and money that are necessary to onboard the new aircraft and owner and then to quicky have to offboard them. These costs include legal documenting costs, internal hours, and most important personnel issues. If pilots, flight attendants and/or maintenance technicians were hired by the management company during the on-boarding process, then the crew will need to determine (with the help of the aircraft owner and management company) if they should stay with the current management company or move to the new management company.

Finally, in some instances the charter revenue expected is not being realized. The reasons for such charter revenue shortfalls range from overestimated revenue, increased maintenance costs, or aircraft availability issues due to more owner flights than predicted. Additionally, there have been long delays in getting the approvals necessary to add aircraft onto Part 135 certificates, thus delaying the generation of charter revenue with the aircraft.

On a brighter note, since we continue to be in Seller’s market, buyers who purchased their aircraft at the start of the pandemic can now become sellers and realize tremendous gain. I have seen several previous buyers become sellers and earn enough profit on the sale to cover the operating costs of the aircraft for the two years the aircraft was owned. However, once the aircraft is sold, the aircraft owner will have difficulty finding a replacement aircraft. In addition, there continues to be long lines to join membership programs or fractional programs. Another trap to be aware of for the buyer turned seller- the sale of the aircraft may also cause tax issues, if the aircraft was used for business and depreciated more than the sales price.

Going forward, what can be done if we continue to stay in an imbalanced sellers’ market? If a full pre-purchase inspection is not possible, hire technical experts to spend a day or two with the aircraft and records for a detailed visual inspection and records review prior to the closing. With the right technical team some, but not all, issues can be discovered without a full pre-purchase inspection. This should help with the development of an accurate operating budget. Additionally, before an aircraft is even found, management companies can be interviewed. This way the right management company will be ready to engage when the aircraft is purchased.

In an ideal world full pre-purchase inspections would become the norm again and deals would progress a bit slower as a result of the longer inspection timeline. However, until that happens, hiring the best available technical representatives for a limited scope of inspection is the next best thing, along with working in advance to select a management company to manage the aircraft.

Over the past two years, the charter market has grown, and more people are flying privately than before the pandemic. One challenge facing charter operators is how to add more aircraft onto their Part 135 certificate in order to accept more charter flights and grow their charter revenue. To overcome this challenge, some charter operators have purchased their own aircraft, started to guarantee or increased the guarantee of charter revenue to aircraft owners and entered into exclusive leases with guaranteed fixed lease rates for multiple years with aircraft owners.

When an aircraft owner is considering allowing their aircraft to be chartered, it is important to realize that the charter operator is responsible for the scheduled and unscheduled maintenance on the aircraft and the appearance of the interior and exterior of the aircraft. This responsibility, however, may cause the charter operator to face competing interests. Specifically, seeking to maximize charter revenue to satisfy and meet the demands of the charter customers while maintaining the aircraft to the highest necessary safety standards.

This conflict can be more pronounced when the charter operator is also responsible for the costs associated with maintenance and/or appearance of the aircraft. If the charter operator has the obligation to pay for all maintenance while the aircraft is being operated by the charter operator, then an unscrupulous charter operator may try to defer certain maintenance obligations to maximize charter revenue. While such deferments are sometimes permissible under the regulations, such deferrals can impact the future condition of the Aircraft and increase the cost and duration of the maintenance events.

Aircraft owners must mitigate the associated risks with the exclusive charter lease by having certain terms in the agreement with the charter operator.

First, the agreement between the aircraft owner and the charter operator should clearly set forth the obligations of the charter operator about maintaining the aircraft. Specifically pertaining to what standards the aircraft must be maintained and if deferred maintenance is allowed. It may also be helpful to require that the aircraft return to the same maintenance facility on a regular basis so that the same technicians can service the aircraft and monitor any reoccurring issues.

For example, an undiscovered water leak or a water leak that is not immediately remedied properly could cause additional damage to the aircraft. As a result, it is important for the charter operator and aircraft owner agree in writing on the amount of time that the aircraft can be operated while deferred maintenance remains open.

Additionally, the owner of the aircraft should have a right to inspect the aircraft and the aircraft documents with reasonable notice on a regular basis. This will allow the owner to hire a technical expert to make sure the aircraft is being maintained in accordance with the terms of the agreement, government regulations and the manufacturer’s guidelines. It is important that the aircraft owner not only has the right to inspect the aircraft but also exercises the right at least annually to avoid any significant surprises related to the condition of the Aircraft.

The aircraft owner must have an expressed right to repossess the aircraft and terminate the agreement if material conditions are breached, including but not limited to, failure by the charter operator to (i) maintain the aircraft, (ii) insure the aircraft, (iii) pay for items required under the agreement or (iv) maintain clear title by allowing liens to attach to the Aircraft.

Most importantly, the aircraft owner should have the right to conduct a return inspection during the last month of the agreement and a corresponding requirement for the charter operator to be responsible to fix any necessary repairs (allowing for any normal wear and tear). At the end of the lease, the aircraft must meet a list of well-defined return conditions that are set forth in the agreement at the expense of the charter operator. The aircraft owner should be able to select the inspection facility at which the return inspection is conducted to ensure the inspection is completed by an independent third party.

With the new charter customers that started flying privately during the pandemic, it is predicted that charter activity is going to remain higher than it was pre-pandemic. As a result, charter operators will continue to create new ways to meet the increased charter demand. Consequently, if an aircraft owner is allowing its aircraft to be chartered through an exclusive lease, then it is important to remember to take the outlined steps required to protect the aircraft so that the charter use does not negatively impact the value of the aircraft.

Aircraft that are enrolled in maintenance and subscription programs, such as those covering airframes, engines, and maintenance tracking, are often more marketable and more valuable, than compared to aircraft that are not covered by such programs and subscriptions. There is real value to an aircraft buyer in having the programs and subscriptions on the aircraft when it is purchased. As a result, it is important that the programs and subscriptions are transferrable as part of the acquisition process.

Each third-party provider differs in how they handle the transfer or assignment of programs and subscriptions. Some providers simply allow the seller to assign the current contract to the buyer, but many require the buyer enter into a new agreement. It is important that the buyer understand the cost of the programs and subscriptions when putting together the budget for the ownership and operation of the aircraft. It is also important that all of the necessary paperwork be handled in a timely manner, keeping in mind that some providers will not send out the transfer paperwork until the purchase of the aircraft has been completed.

When progressing through the aircraft purchase process, the buyer should consider the following:

1. Purchase Agreement Requirements:

a. Prior to the execution of the purchase agreement, request copies of the current maintenance program agreements from the seller. Confirm that the advertised programs are in place at the rates previously provided.

b. If the program provider(s) will not complete the transfers until after closing, make sure the purchase agreement requires the transfer obligations of seller extend beyond the closing.

c. For annual maintenance or subscription payments, make sure the purchase agreement is clear that the payment will be prorated based on the closing date or as otherwise agreed upon between the parties.

d. If the buyer elects not to continue with a program or subscription, make sure the purchase agreement allows the buyer to terminate the program or subscription upon closing and stipulates which party must pay any fees associated with the termination.

2. If the aircraft is being financed, make sure the lender documents allow sufficient time to get the transfers in place. Since the process is controlled by the providers, it is difficult for the buyer to dictate to the providers a timeline put in place by the aircraft lender.

3. If there are minimum flight hour requirements under the program, make sure the minimums can be met by the buyer and if not, see if the program requirements can be revised.

4. During the inspection process, contact each maintenance provider and subscription service and inform them of the pending purchase and request a balance on each of the accounts and what date they have been paid through. Often the maintenance provider or subscription service requires seller’s approval to disclose account information.

5. Confirm with the maintenance or subscription service providers the transfer process and related timeline. Since each provider may have their own process, it is a good idea to create a document that tracks the transfer process for each program and subscription.

6. Closing should only take place after third party confirmation that all programs and subscriptions are paid through closing or otherwise in accordance with the purchase agreement.

7. Once the closing has occurred, promptly send notification of the closing to the program and subscription service providers. Some providers will want a copy of the delivery receipt showing the number of hours on the aircraft/engine(s) at the time of closing. They may also want a copy of the bill of sale and perhaps additional documentation regarding the new owner. Be sure to provide all required documents without delay.

8. Continue to follow up with the providers until the transfer of all applicable programs and subscriptions are complete.

Since there is material value to the aircraft programs and subscriptions associated with the aircraft, it is important that all of the paperwork is completed in a timely manner, so the aircraft remains enrolled on the programs and subscriptions bargained for as part of the aircraft purchase.

When sharing an aircraft, advanced planning and documentation can preserve the relationship of the parties and allow the ownership arrangement to outlive potential disputes.

As I’ve described previously, this is an exceedingly difficult market for those looking to fly privately. One traditional way to avoid long wait times associated with the purchase of a private aircraft had been fractional ownership. However, the market dynamics have shifted such that this avenue now presents its own challenges.

Not only is the waitlist for fractional share ownership pushing into 2024 for some aircraft but starting an interim lease until the fractional purchase share is delivered is no longer an option. Further, some of the jet card membership programs and fractional programs continue to struggle to meet the on-time performance metrics they achieved pre-pandemic. Finally, quality charter options continue to remain scare and significantly more expensive than they were two years ago.

As a result, I am seeing more of my clients look to purchase their own aircraft with one or two associates. This too is also a challenge given the shortage of available pre-owned aircraft. However, it is likely that an aircraft can be sourced and closed in 2022, which presents many with a more desirable option than fractional ownership in 2024.

Once the parties have decided to share an aircraft, the first decision is whether the ownership will be co-ownership or joint ownership. Under a co-ownership structure, multiple companies and/or individuals share in the ownership of the aircraft. Each co-owner operates the aircraft and provides its own crew. The crew can be provided by each co-owner independently or through a management company. Co-owners are not able to charge each other for operating the aircraft. This is the major distinction between co-ownership and joint ownership.

Under joint ownership, which is defined in 14 CFR 91.501(c)(1) of the Federal Aviation Regulations (FAR), one of the joint owners employs and provides the crew and each of the other joint owners pays the amounts defined under the joint ownership agreement. Each joint owner is responsible for its direct operating costs of the aircraft. All joint owners must be on the registration certificate of the aircraft. Joint ownership rules only apply to aircraft that can operate under FAR Part 91, Subpart F, but smaller airplanes and helicopters operated under the NBAA small aircraft exemption can also use the cost reimbursement options under Part 91, Subpart F.

Regardless of whether an aircraft is co-owned or jointly owned, the owners should enter into a user agreement to address, in advance, these potential issues.

1. Scheduling
a) Will the aircraft be reserved on a first-come, first-served basis? Is this fair if one owner has the flexibility to plan further in advance than the other?
b) How far in advance can the aircraft be reserved? For example, can one owner reserve the day after Thanksgiving for the next five years immediately after becoming an owner?
c) Do one or all owners have frequent pop-up trips that could conflict with another owner’s needs?

2. Costs
a) Will fixed costs be shared equally or based on a percentage of the annual usage?
b) If based on usage, can the annual usage be reasonably predicted?

3. Management
a) Will a management company be used to operate the aircraft?
b) If so, how do the owners reach agreement on which management company to hire?

4. Extended trips
a) How often does one owner need the aircraft for multi-day trips that keep the aircraft inaccessible for the other owners?
b) What obligation does an owner have to return the aircraft to its home base if it’s not going to be used for several days between stops on an extended trip?

5. Shared Usage
a) Do the owners travel to the same areas of the country and would sharing the aircraft for those flights be desirable for all owners?

6. Charter
a) When the owners are not using the aircraft, will it be placed on a Part 135 certificate for charter?
b) If so, if a charter flight is booked, can an owner reservation trump the charter flight?

7. Allowable Activities
a) Will smoking be allowed on the aircraft?
b) Will large or small pets be permitted and, if so, under what conditions?

8. Upgrades
a) Do the owners have similar views on safety upgrades that may not be mandatory?
b) What about amenities such as wifi and upgraded avionics?

9. Dispute resolution
a) If and when conflicts arise, is there a procedure in place for resolving conflicts in a very specific and cost-effective manner?

10. Termination – at some point, an owner will no longer want to own the aircraft
a) Will the non-selling owner be entitled to a right of first refusal?
b) If one owner wants to sell and the other does not, will a sale of the aircraft be required?
c) What will be the terms of the sale, including the mechanism for pricing the aircraft?

Sharing an aircraft can lead to conflict. It should never be assumed that just because the owners are associates that they will be able to work issues out as they arise. The best way to avoid future conflicts is to create a user agreement which is very specific and thorough and anticipates as many of these friction points as possible. A well-drafted user agreement, signed when the aircraft is purchased, can act as the non-biased document that all owners look to for guidance. The more answers found in the user agreement, the less likely it is that the conflict will escalate.

Since not every possible conflict can be contemplated in advance, the user agreement must contain a specific dispute resolution provision and a termination provision. Additionally, if the owners no longer wish to own the aircraft together, an unwinding process should be documented that is satisfactory to the parties.