Interest rates remain at historic lows, in part due to the Federal Reserve Bank’s continued efforts to keep them there. Doesn’t this mean that you should finance your next business jet purchase?

A good case can be made for doing just that. A jet owner I spoke to recently seemed interested in upgrading to a bigger, more expensive airplane simply to have an excuse to borrow money. Rates won’t stay low forever. If you can finance a jet purchase at an attractive rate for the next seven years, there’s a pretty fair chance that will look like a good deal at the end of the term.

You might expect that a jet buyer who wants to take advantage of low interest rates would choose a fixed-rate loan. But Ford Von Weise at Citi Private Bank said that most of its clients opt for floating LIBOR indexed rates. Ultra-high-net-worth borrowers can finance the purchase of a business jet today at a rate that’s well below 2 percent.

On the other hand, it’s hard to justify borrowing if you have a lot of cash. While low interest rates make loans cheap, they also minimize investment returns. Money markets and certificates of deposit earn almost nothing, and though longer-term debt investments may offer higher returns, they involve substantial risk. Warren Buffett reportedly said recently that long-term government bonds today are “the dumbest investment.” When rates go up, as someday they surely must, the price of those bonds will fall. A lack of good conservative investment options causes some jet buyers to invest their cash in a new aircraft.

This is the reverse of the situation a few years ago. In 2007, before the crash, a growing group of lenders competed ferociously to finance aircraft purchases. Good collateral, blue-chip borrowers and the possibility of other business opportunities proved irresistible to many lenders. All that changed when the market crashed in 2008, and aircraft finance has been slowly rebuilding ever since.

Of course, if you don’t have cash, financing may be the only way to buy the aircraft. Many high-net-worth individuals have their money locked up in illiquid investments, such as securities of privately held companies or restricted shares in public companies. Those securities can often be pledged to secure a loan to acquire an airplane. When a “liquidity event”­—the sale of a business, for example—is on the horizon, borrowers often plan to pay off the aircraft loan at that time.

Perhaps the best reason to finance your purchase is that you may have better things to do with your money than tie it up in an airplane. Though many conservative investments are showing low returns, less conservative ones obviously still offer earnings better than 2 to 3 percent per annum. Investors were gun shy for a while, but as one lender told me, more people now want to pursue higher-risk, higher-reward opportunities. Financing your purchase lets the bank tie up its money in a conservative investment while you pursue a more aggressive investment strategy.

But you should avoid being stuck in an unattractive financing. If the plan is to take advantage of ultra-low floating rates in the near term, consider adding an option to switch to a fixed rate if it looks as if rates will be going up. If the long-term strategy is to pay off the debt when interest rates rise to a level that makes the financing unattractive, avoid loans with blackout periods and prepayment penalties. According to Von Weise, Citi often allows its aircraft loans to be paid off at any time without penalty.

In part, a readiness to permit repayment of aircraft loans reflects the fact that the profitability of aircraft finance has been compromised by the capital reserves and liquidity requirements that banks—especially “systemically important” ones like Bank of America, Citi and Wells Fargo—are being required to keep pursuant to the Basel III accords. (See my article on the “Changing Face of Aircraft Lending” in BJT’s February/March 2013 issue.) Given the razor-thin margins of profitability on many aircraft loans, a bank may be delighted to discover that a borrower wants to pay one off.

Another reason to finance an aircraft acquisition cited by lenders is to avoid the risk of taking a loss on the purchase. One aircraft finance veteran told me that he is seeing many companies—Fortune 500 companies, for example—lease aircraft that never would have dreamed of doing so in the past. A lease typically offers a definite payment structure for a definite period of time, with no residual risk. When the lease ends, there’s no finger pointing at the company about why the aircraft turns out to be worth a lot less than expected. If its value has plummeted, that’s the lessor’s problem.

Moreover, the pending changes to lease accounting rules are unlikely to take effect until 2016 or 2017, according to aviation CPA Glenn Hediger, so in the meantime, leases still provide off-balance-sheet treatment for companies that don’t want to highlight possessing an aircraft. If you can’t use the tax-depreciation benefits of an aircraft purchase, a lease also has the potential of passing those benefits to you in the form of lower financing costs.

If you plan to lease, a factor that may make financing easier is the availability of bonus depreciation for factory-new aircraft delivered this year. This lets you write off the whole purchase price, assuming you’re eligible for bonus depreciation and can satisfy the special tests in 2013 for the 100 percent version. If you fail those tests but are otherwise eligible, you can still qualify for 50 percent bonus depreciation for factory-new aircraft delivered in 2013 and 2014. This allows you to write off a total of 60 percent this year in most cases, since you’re entitled to an additional 10 percent based on the normal MACRS depreciation schedule for the remaining 50 percent of the cost. If your financial institution buys the aircraft and leases it back to you, however, that institution gets the benefit of the bonus depreciation.

Bankers Like Some Airplanes More than Others

Lenders pay close attention to the cost, age and model of the aircraft. Suppose you’re buying a 1983 Challenger 601 for $1.5 million. It may be a perfectly good aircraft at the right price, but it won’t be attractive to a lender. First, it is well beyond the age tolerance of most lenders, who are looking for airplanes that won’t be more than 20 or 25 years old when the financing ends. Second, it is in a buyer’s market: almost 23 percent of Challenger 601s are reportedly available for sale or lease at present. No lender wants to have to resell an aircraft like that when the lease ends or the airplane is foreclosed on. Finally, the bank will put at least as much work into this $1.5 million financing as it would into financing a $50 million Global 6000.

As a result, one bank whose rep I spoke to has three tiers of aircraft: most desirable, somewhat desirable and undesirable. Factory-new or relatively new large-cabin and long-range models like the Global 6000, Gulfstream 550 and Falcon 7X inhabit the first category. For qualified buyers, the bank will work hard to win that business. Buyers of aircraft in the “undesirable” category will mostly likely have to go elsewhere for financing.

Will they find it? Maybe, but they’ll have to know where to look. Financing for a problem aircraft, a problem buyer or a problem structure probably fits in best at certain non-bank companies willing to take higher risks for a greater return. But with rates as low as they are, even these financings may prove more attractive than you expect. It doesn’t hurt to look.

Private and Commercial Banks and Affiliates

Banc of America Leasing



Global Corporate Aircraft Finance

Addison, Texas

Michael T. Amalfitano

(972) 455-5855



CBI Leasing, Inc.

Aircraft Finance

Commerce Bank N.A.

Lake Forest, Illinois

Sean K. Patrick

(847) 295-4601



Chase Equipment Finance, Inc.

Tampa, Florida

Chad E. Colby

(813) 483-8246



CIT Bank

CIT Aerospace Business Aircraft

Plantation, Florida

Michael J. Kahmann

(954) 359-4646



Citi Private Bank

Global Aircraft Finance

New York

Ford von Weise

(212) 559-1444

City National Bank

Aircraft Finance Group

Irvine, California

John Unchester

(917) 558-8460



Deutsche Bank Private

Wealth Management

Private Aviation Finance

Chicago

David W. Rodin

(312) 537-1510



Fifth Third Bank Leasing

Boston

Matt McNamara

(617) 573-5191



First Republic Bank

Aviation/Marine Finance

San Francisco

James F. Simpson

(415) 296-5783



First Source Bank

Downingtown, Pennsylvania

Jeffrey Lindstadt

(610) 269-1683



Key Equipment Finance

Corporate Aviation Finance

Boston

Patti Ann Sullivan

(978) 261-5201



PNC Aviation Finance

Boise, Idaho

Wayne Starling

(888) 339-2834



RBS Asset Finance

Manchester, New Hampshire

Donald A. Synborski

(603) 634-7522



SunTrust Equipment Finance & Leasing Corp.

Corporate Aircraft Finance

Towson, Maryland

John J. Amato

(303) 775-6631



U.S. Bank Equipment Finance

Capital Equipment Group

–Corporate Aircraft

Denver

Pete J. Georgelas

(303) 585-4036



Wells Fargo Equipment Finance, Inc.

Corporate Aircraft Division

Los Angeles

Robert C. Lebano

(310) 789-5036

Other Financial Institutions



Cessna Finance Corp.

Wichita, Kansas

Perry Bridges

(316) 660-1392



Export-Import Bank of the United States

Transportation Division

Washington, D.C.

Robert F.X. Roy, Jr.

(202) 565-3557



GE Capital Corp.

Corporate Aircraft Finance

Danbury, Connecticut

Brent P. Godfred

(203) 749-6657



Guggenheim Partners, LLC

Business Aircraft Investments

New York

Chris Miller

(212) 293-2818



Prudential Capital Group

Atlanta

Robert Penfold

(770) 701-2410

Two corporate aircraft runway accidents in recent years underscore the importance of understanding your aviation insurance policy and communicating key details to all pertinent parties. The 2007 accidents—in Nova Scotia, Canada, and Santa Barbara, California—resulted in no serious passenger injuries but caused millions of dollars’ worth of damage. In each case, the insurance carrier denied the claim because the pilot(s) failed to meet policy requirements.

Contrary to popular belief, insurance companies don’t like to reject claims. It’s bad PR for them and isn’t conducive to retaining their other policyholders. However, when aircraft owners fail to adhere to contract terms, insurers have little choice but to say no.

Here’s a look at the four mistakes that result in the largest percentage of claim denials. Avoid them and you’ll have the bulk of your coverage nailed down tight.

1. Using Unapproved Pilots

One of the easiest and most common ways to void your insurance is to allow someone to fly your aircraft without confirming that he or she meets your policy’s approved-pilot clause.

The policy will state exactly who is authorized to act as pilot in command or second in command. Typically, either these pilots will be listed by name or you’ll see an “open-pilot” clause, which stipulates broad credentials and experience required to operate the airplane.

Many policies also list additional mandatory requirements for pilots. For example, your insurer may stipulate that all pilots, whether named or conforming to an open-pilot clause, must annually complete a motion-based simulator training course designed for the make and model aircraft operated. (A Falcon 900 doesn’t equal a Falcon 2000.) After a loss, a claims adjuster would require documentation that the pilot flying the aircraft had, in fact, completed such training.

Insurance companies recognize the need for flexibility regarding who is allowed to fly your airplane. This is the intent of those open-pilot clauses. For example, if your regular pilot is ill or on vacation, this clause can give you the authority to ­utilize another pilot who meets the minimum standards set forth in the policy. The open-pilot clause isn’t designed to allow you to let other pilots operate the aircraft on a regular basis, however, so be careful when relying on this provision.

Some aircraft owners mistakenly believe it’s OK for a pilot who hasn’t been approved by the insurance company to receive instruction or log time, provided that someone who’s “insurance-approved” acts as pilot in command. However, insurance carriers define pilot in command to mean “sole manipulator of the controls.” Therefore, if the pilot handling the controls at the time of a loss isn’t approved under the policy, no coverage will apply.

Keep in mind that investigators attribute most accidents and incidents to pilot error. At each renewal of your insurance, you should provide your pilots with a copy of the approved-pilots section of your policy and encourage them to keep it in the cockpit as a reminder. Make certain they complete required recurrent training within the allotted time, as no grace period applies. You should list by name on the renewal application any pilot you employ regularly. Prior to using new pilots, have them complete a form verifying their credentials. Ask your insurance broker to submit that form to your insurance carrier and get its blessing.

2. Misunderstanding Approved-Use Clauses

One of the least understood and therefore most dangerous clauses in an aviation insurance policy is the one about “approved use.” This provision spells out what commercial or non-commercial uses the insurer will cover and what compensation the aircraft owner may receive for operation of its aircraft. Particularly with respect to policies written for non-commercial use, allowable reimbursement can vary widely.

The most basic and restrictive clause would allow for use in the insurance holder’s business as well as personal use, but not for hire or reward. In other words, any exchange of goods or services—be it a week at a friend’s vacation home or a case of your favorite wine—could violate the policy terms.

A more liberal wording of the usage clause would state that the policy shall not apply while the aircraft is used with the insured’s knowledge “for any purpose involving a charge intended to result in financial profit to such insured unless otherwise indicated herein.”

An even broader clause would cover “all operations of the named insured.” Insurers normally reserve this language for their best corporate-flight-department customers. It allows maximum flexibility on reimbursement for aircraft operations. If you can get it, this is the clause you want.

Why are insurers so focused on commercial versus non-commercial use? Because in the eyes of the law, an entity engaged in a commercial operation owes a much higher standard of care to the public. The courts will hold the commercial operator—and therefore the insurance company—much more liable than a non-commercial operator.

3. Incorrectly Listing "Named Insured"

The “named insured” is the policy’s owner—the person or company that is entitled to cancel, add, change and benefit from coverage and that has the right and responsibility to coordinate with the insurer on any claim, receive claim checks, return premium checks and respond to cancellation notices. An “additional insured,” on the other hand, simply shares certain parts of the liability coverage and does not have any other rights under the policy.

Many owners mistakenly list the registered owner (often a sole-asset LLC) as the only “named insured” and sometimes list the true operating company or principal owner as an additional insured. Consult with your insurance broker to determine whether it makes sense in your situation to list all owners as named insureds. If your policy doesn’t already have it, add the “broad form named insured” clause.

Properly structuring the named insured is crucial to assuring that coverage applies to the people or entities that need it. Why? Because many ancillary coverages, such as for use of non-owned aircraft, apply only to the named insured. For example, say the owner’s aircraft is on a flight and another executive of the company must therefore use charter. If the flight is chartered under the operating company’s name and that company isn’t listed as a named insured, the coverage for use of non-owned aircraft wouldn’t apply, leaving the operating company exposed to a lawsuit in the event of an accident.

You might think you needn’t worry about that and that your company couldn’t be sued if all you did was charter an aircraft. In fact, when an accident occurs, typically everyone involved in the loop of commerce for that flight will be brought into a lawsuit. One great benefit of your liability coverage is that it provides an attorney to defend you, even against a suit that is groundless.

Because the wording of aviation policies varies, it is critical that you review your risk profile with your insurance broker so he or she can help you properly structure your policy’s named-insured clause. The penalty for not doing so could be financial ruin.

4. Failing to Properly Review Contracts

Many of us routinely sign rental-car agreements, bank-loan documents and website use clauses without even a cursory review. Why? Because they’re long and loaded with legalese. That’s also true of aviation contracts—including purchase, financing and maintenance agreements, hangar leases and more—but the consequences of not reading and understanding them before you sign could be much greater. Among other things, these contracts could significantly affect your insurance coverage.

It is essential that you provide a copy to your insurance broker and attorney before you sign any such agreement. Almost without exception, they contain clauses requiring you to meet certain insurance conditions. Ignore these and you may find yourself in a nasty breach-of-contract lawsuit. In addition, most of these agreements contain indemnity clauses that—regardless of any insurance coverage you have—make you responsible for any losses.

Indemnity clauses merit particularly careful review as they can work against you in their most onerous form. Your aviation attorney can guide you through the process and suggest wording based on language common to the industry. The money you might save by not taking this step would seem trivial after a loss. So if you want to avoid the cost of an attorney, do it on contracts that don’t involve as much loss exposure. It just makes sense.

HULL AND LIABILITY INSURANCE BROKERS



Air-Sur, Inc.

Ormond Beach, Florida

Thomas K. Coughlin, (386) 672-6210



AirSure Ltd., LLC

Golden, Colorado

Bill Behan, (303) 526-5300



AON Risk Services, Inc.

New York, New York

Tracy Toro, (212) 479-3233



AIS Gallagher

Las Vegas

Brad Meinhardt, (702) 647-2333



Chartis Aerospace

Insurance Services, Inc.

Atlanta

Linda Parent, (404) 249-1800



Falcon Insurance Agency, Inc.

Kerrville, Texas

John Allen, (830) 257-1000



Frank Crystal & Co., Inc.

New York, New York

Louis M. Timpanaro, Jr., (212) 504-5850



Hope Aviation Insurance, Inc.

Columbia, South Carolina

Stuart Hope, (800) 342-4673



John F. Throne & Co.

Seattle

Brint Smith, (206) 622-3636



Insurance Office of America

Aerospace Division

Atlanta

John C. Averill, (770) 308-2398



L.L. Johns & Assoc., Inc.

Waterford, Michigan

Stephen Johns, (248) 666-4400



Marsh USA, Inc.

Atlanta

Nancy P. Gratzer, (404) 995-2480



NationAir Insurance Agencies, Inc.

W. Chicago, Illinois

Jeff Bauer, (630) 584-7552



PIM Aviation Insurance

Wichita, Kansas

Timothy K. Bonnell, Sr., (316) 942-0699



Travers Aviation Insurance

St. Louis

Glen Travers, (800) 888-9859



Wells Fargo Insurance

Services USA, Inc.

Cincinnati

Charles R. Tooley, (513) 333-2121



Willis Global Aviation

New York, New York

Melissa Harder, (212) 915-8213



Wings Insurance Agency, Inc.

Eden Prairie, Minnesota

Steve Bruss, (952) 942-8800

TITLE INSURANCE AGENT



Global Aviation Title

Insurance Agency, LLC

Oklahoma City, Oklahoma

Frank L. Polk, (405) 552-2201

Maybe not, but you’d be wise to carefully consider the question.

Unlike real estate lenders, most aircraft lenders don’t require title insurance, so airplane buyers rarely even know about it, let alone purchase it. That can be a big mistake.

As the name implies, title insurance covers your title to the aircraft, ensuring that you own it free and clear of liens and encumbrances. 

The list of potential title problems is sobering: forged de-registration notices, bills of sale or releases; invalid documents due to lack of signing authority or incompetence; litigation involving the aircraft; state and federal tax liens; mechanics’ liens—the list goes on. Title insurance guru Frank Polk compiled a list of more than 60 things that can go wrong with an aircraft’s title—most of which have been litigated—that might make you reconsider the value of this coverage.

Title concerns often arise when a buyer acquires an aircraft based or registered outside the U.S. A leading case illustrating the potential horrors of purchasing a foreign-registered aircraft is Faysound Ltd. v. Walter Fuller Aircraft Sales. Defendant Fuller purchased a Falcon 50 from the Philippine Presidential Commission on Good Government (PCGC), an organization supposedly recovering ill-gotten wealth from former cronies of deposed president Ferdinand Marcos. The PCGC had “seized” the Falcon in connection with a court proceeding against one Eduardo Cojuangco, Jr.; the Philippine registration of the aircraft was cancelled; and notice of the cancellation was sent to the FAA, stating that the aircraft was free and clear of lien. Fuller subsequently received a bill of sale from the PCGC (which he duly recorded with the FAA) in consideration of the purchase price, much of which was apparently used to pay off cronies of the new Philippine administration. 

Unfortunately for Fuller, Cojuangco didn’t own the aircraft; he was a shareholder of a company that leased it from a Hong Kong corporation called Faysound, which was the Falcon’s true owner. As a result, the PCGC never had any right to seize or sell it. When Faysound sued the hapless Fuller in a U.S. court to recover its aircraft, Fuller lost.

Title insurance can protect you from such problems, in part because of the due diligence the insurer will perform. If Fuller had purchased title insurance for the Philippines, the insurer would have discovered when checking the Philippine aircraft registry that the registration was merely that of a lessee/operator and was subject to a lease agreement with the real owner.

If the aircraft is based or has significant maintenance performed outside its jurisdiction of registration, you should ask the title insurer what diligence should be conducted and what coverage you can buy to provide the best protection. With the right diligence and coverage, the title insurance process can protect you against improper or forged deregistration notices, fraudulent sales, tax liens and other claims and issues unique to foreign deals (such as the invalidity of documents resulting from the peculiar requirements of a foreign jurisdiction).

A common misconception is that hiring a reputable title company to search the FAA Registry and International Registry for filings regarding the aircraft is sufficient to identify all potential title problems. Neither the FAA registry nor even federal law controls valid title; it’s controlled by applicable state law (or foreign law in the case of many imports), and not all liens are filed with the FAA.

Tax liens—a big source of title disputes since the economic downturn of 2008—offer a good example. “People forget to do tax-lien searches because they think all liens are filed with the FAA and that’s simply not the case,” Polk said. Thus, you can be the registered owner for FAA purposes but still end up in a dispute with the prior owner over a tax lien, perhaps requiring you to pay off a lien claimant.

Even checking FAA records and making a timely filing with the FAA may not win the day, as the parties learned in Shacket v. Philko Aviation. In this case, an aircraft dealer sold a Piper Navajo to Mr. and Mrs. Shacket, telling them he’d file the bill of sale for them with the FAA, as was “customary.” Instead of doing so, however, the dealer then purported to sell the same aircraft to Philko, which did file a bill of sale with the FAA. But even though Philko was the registered owner, the court held that the Piper belonged to the Shackets and found that Philko had “actual notice” that the dealer didn’t have good title to the aircraft. (Notoriously, the court said “actual notice” includes “knowledge of facts that would lead a reasonable person to inquire further into the seller’s title.”) Like Fuller, the folks from Philko probably wished they’d had title insurance. 

Savvy aircraft buyers not only get a bill of sale from the seller at closing; they also get a warranty of title, which is a standard part of nearly all airplane transactions. Instead of paying for title insurance, can’t the buyer simply rely on the warranty? That’s certainly an option, but many aircraft sellers are little more than shell holding companies that may not even exist when title problems surface. Further, a small group of sellers (mostly lenders and leasing companies) refuse to provide a general warranty of title. They may be willing to guarantee that they didn’t muck up the title, but they won’t guarantee that prior owners or other parties haven’t done so. In that case, title insurance is an absolute must, and you should ask the seller to contribute to its cost.

So should you obtain title insurance when buying an aircraft? It depends. The coverage is worth considering in every purchase of a non-U.S.-registered or -based aircraft, although even there, if you’re buying a jet from the queen of England, you can probably live without it. If you’re buying an aircraft based and registered in the U.S., title insurance may be worth having, depending upon the identity and financial condition of the seller, the nature of the seller’s title warranty and the history of the airplane. 

Jeff Wieand welcomes comments and suggestions at jwieand@bjtonline.com.

Reduced inventories of several models suggest that, after years of weakness, the used-jet market is finally turning around.

Though it’s too soon to start celebrating, we’re seeing more and more signs of a turnaround in the market for used jets.

One example: the number of preowned Gulfstream G550s for sale recently dropped below 10—down from 17 roughly a year ago. When you consider that more than 400 of this model are in operation, the small percentage on the used market is impressive. An increase in prices seems unlikely in the short term but we can expect values to at least stabilize if G550 inventory holds at or below current levels, as one might expect heading into the historically busiest sales period of the year. The immediate beneficiary of such stabilization would, of course, be the GV, a model whose inventory has slightly increased year-over-year. 

Supply of Bombardier’s Challenger 604, meanwhile, reached an all-time high at the end of 2012—but then buyers detected value and assaulted this segment with cold, hard cash, driving availability down to levels not visited in a couple of years. Buyers’ acute sense of value can tighten up a market over a couple of quarters, which is what has occurred here. While the Challenger 604 market remains supply-heavy, inventory seems likely to continue shrinking this fall, with levels stabilizing by the end of the year. Lending support to this thesis are the “sale pending” notices that accompany nearly 10 percent of the model’s current for-sale listings, plus a comparatively low supply of the successor model 605s for sale. 

Another large-cabin jet, the Falcon 7X, seems to have arrived at its trigger point, with most of the pricing in the sub-$40 million area. The aircraft has been selling at a rate of roughly one per month over the last six months, double the rate of the previous six months, bringing the number of choices below the 12-month moving average. n

Bryan Comstock welcomes comments and suggestions at bcomstock@bjtonline.com.

Good news: rates are at record lows. Bad news: a rock-bottom rate can trigger trouble.

Leasing plays a big role in business aviation. A lease transfers possession of an aircraft from the lessor (usually, but not always, the owner) to the lessee. If you think of property as a bundle of sticks, as I was taught to do in law school, the lease gives some (but not all) of those sticks to the lessee, including the right to operate the aircraft when it’s in the lessee’s possession.

Aircraft leases are sometimes described as either wet or dry. According to Federal Aviation Administration regulations, a lease is wet if the lessor directly or indirectly provides at least one crewmember along with the aircraft, in which case the FAA requires that the lessor retain operational control of flights. Arguably, this means a “wet lease” isn’t really a lease at all, but rather an agreement by the lessor to provide a transportation service to the lessee. Dry leases, on the other hand, are usually “operating” leases where the lessee operates the aircraft (or subleases it to another party to operate it for him). The lessor remains the owner, enjoying the benefit of tax depreciation and facing the burden of market depreciation.

There are many reasons to lease business jets. Leasing is currently the customary way for an owner to provide an aircraft to a Part 135 certificate holder for charter flights. Leasing is also a classic way of separating in different entities the liabilities associated with owning and operating an airplane. Many leases are designed to make aircraft available to affiliates of the owner or to avoid payment of sales or use tax on an airplane purchase. Financial institutions offer operating leases (usually between five and 10 years) to customers as an alternative to debt financing.

What’s a fair lease rate for an aircraft? It depends. Financial institutions consider a host of factors in setting the rate, including the term, interest rates, the lessee’s credit position, the availability of options for the lessee to purchase the aircraft and its estimated fair market value on termination. Lease rates to charter operators for purposes of revenue charter reflect the assumed hourly cost of operating the aircraft and the anticipated hourly revenue. As a rule, the charter operator will pocket approximately 15 percent of the gross revenue (excluding the fuel surcharge) and give the balance to the owner as a lease payment. Lease rates between aircraft owners and operators usually involve informed, arm’s-length negotiations based on the value of the aircraft.

But suppose there is no arm’s-length negotiation. In a typical business-jet ownership structure, a subsidiary company acquires the aircraft and immediately leases it to its parent company or another affiliate to operate. The purpose of this arrangement is often to minimize sales/use taxes by switching the target of the tax from the purchase price to the lease payments. Essentially, the initial transaction is regarded as a purchase for resale, so the ultimate “sale” subject to tax is the monthly (or hourly) lease.

In situations like this, there is an irresistible temptation to make the lease payment as small as possible. Assuming the applicable sales tax is 6 percent, if the aircraft is leased for $200,000 per month, the monthly tax is $12,000, and if it is leased for $20,000 per month, the monthly tax is a vastly preferable $1,200. But as aviation attorney Cliff Maine is fond of saying, pigs get fat and hogs get slaughtered. A state is unlikely to recognize an agreement as a bona fide lease if the rate is too low. When the state revenue department figures out that you low-balled the lease rate, it may impute its own rate or perhaps disregard the lease altogether and charge use tax on the full purchase price. Interest and penalties will follow as night follows day.

So how do you set a realistic lease rate? For a long time, the rule of thumb was 1 percent of the aircraft’s value per month. Applying this rule, a $200,000 monthly rate would be perfect for an aircraft you just bought for $20 million. But the cost of funds today is so low that the 1 percent per month rule has lost much of its relevance. Most monthly operating lease rates are well below 1 percent per month, especially for long-term leases of new or near-new aircraft, and sometimes as low as 0.4 percent.

Note that in setting the rate, the aircraft is valued as of the beginning of the lease, so if you’re paying $140,000 per month in the first year on a $20 million aircraft (0.7 percent), the percentage of the aircraft’s actual value represented by that payment will be much greater 10 years later. This is one reason, no doubt, why rates tend to be significantly higher for short-term leases (up to three years) than for long-term ones. If this concerns you, you could try to “mark the lease rate to market,” as it were, on some regular basis, to take into account the aircraft’s depreciation in value.

But even an economically sensible lease rate may not work in every jurisdiction. Some states have lease rate expectations more suitable for when Nixon was president. To take advantage of the resale exemption in Texas, for example, a lease between related parties must be in the “normal course of business,” and Texas has decided that a monthly lease rate of less than 1 percent (and more recently less than 1.13 percent) doesn’t qualify. As a result, when entering into a lease between related parties, it’s wise to obtain a written rate appraisal from an established professional that you can retrieve from the file when the state revenue agent knocks on the door. 

Aircraft sales-tax expert Phil Crowther suggests that you might try to provide in your lease that if the state decides the rate is too low, it is automatically and retroactively revised to be the minimum rate the state deems reasonable. That’s an interesting idea, but one yet to be tested in practice. Meanwhile, remember that hogs get slaughtered. 

Jeff Wieand welcomes comments and suggestions at jwieand@bjtonline.com.

Calculating the cost of personal use is as complicated as it is important.

When an employee takes a personal flight on his company’s aircraft, how do you calculate the trip’s cost or value? The answer depends on who’s asking the question and why.

The Federal Aviation Administration generally prohibits passengers from paying for flights that aren’t operated under a commercial certificate. “Payment” means forking over any kind of direct or indirect compensation. The FAA says, however, that if the flight is “within the scope of and incidental to” a company’s business, it can charge the employee the cost of “owning, operating and maintaining the airplane.”

That’s a broad standard for figuring costs. In interpretations, the FAA has said it’s acceptable to use the cost of aircraft usage as established by the company’s accounting department in the normal course of business and that the cost could represent a pro-rata portion of “all fixed and variable overhead expenses associated with the aircraft.” More recently, as part of a convoluted analysis that sowed more confusion than elucidation, the agency said that the cost could even include depreciation of the airplane.

On the other hand, if an employee’s flight is for personal purposes (and is thus not “within the scope of and incidental to” company business), such charges are prohibited. Instead, FAA regulations permit the employee in some cases to “time share” an aircraft for an amount equal to twice the actual fuel costs, plus certain stated expenses. Barring astronomical fuel prices, this amount won’t cover all of the company’s expenses for the flight—certainly not a pro-rata portion of the cost of owning, operating and maintaining the aircraft.

Compare this with the Internal Revenue Service’s approach. The IRS is interested in the cost or value of a flight for two main reasons. First, if an employee travels on company aircraft for personal purposes, the agency treats the flight as a perquisite and the employee as a recipient of taxable income. The IRS gives the company a choice in calculating the amount of that income. To the extent that the employee doesn’t pay for the flight, the company must impute his income using either the ride’s fair market value or a calculation method called SIFL. The former is basically the cost to charter the aircraft, while the latter reflects the cost of first-class airfare. Needless to say, the two numbers will be very different.

The second reason the IRS is interested in the cost or value of a flight is to determine the company’s deductible expenses for tax purposes. Companies usually want to deduct the cost of employees’ personal flights on their aircraft as a business expense. In 2004, though, Congress made this more difficult by limiting the write-off for certain top executives (so-called “specified individuals”) to the amount paid by (and/or income imputed to) those executives when the flight is for their “entertainment, recreation or amusement.” As a result, whenever a specified individual takes a non-business flight, a big chunk of the company’s expenses are often at risk of being disallowed for tax purposes.

How big a chunk? Since the IRS lets the company calculate income to the employee for the flight based on charter rates or Standard Industry Fare Level, one might think the business could use the same approach to calculate its lost deductions. Unfortunately for the company, that doesn’t work. IRS regulations provide that all fixed and variable flight costs—including an allocable portion of any interest expense used to finance the purchase of the aircraft, plus lease payments and tax depreciation on it—are at risk of being disallowed.

IRS rules for how to calculate these costs and assess the amount of the tax deduction disallowed are extraordinarily complicated and sometimes counterintuitive, and enterprising aviation tax accountants have created software to help the company do the job. The bottom line: if top executives frequently use the aircraft for personal “entertainment, recreation or amusement,” the company’s tax bill will go up.

Ironically, this inability to deduct entertainment flight costs creates yet another “cost” for the company—taxes—and yet another headache (this time for public companies) in calculating the cost of personal-use flights.

Like the IRS, the Securities and Exchange Commission regards free or discounted flights for employees on the company aircraft as a perquisite. In the case of free flights on corporate aircraft for certain top executives (often called “named executive officers”) that aren’t part of their employment duties, the SEC requires public companies to report what the commission calls the “aggregate incremental cost” of the flights as “other compensation” to such executives in the proxy statement. Unlike the FAA, the SEC isn’t focused on whether the executive can pay for the flight, and unlike the IRS, it doesn’t care what the actual value provided to the executive is. Its only concern is the additional cost the company incurs in providing the transportation, which has traditionally been thought to be similar to the direct operating costs (DOCs) of the flight—an amount less than, say, the cost of chartering the aircraft.

But as we just noted, if the IRS deems the executive’s flight “entertainment,” the company stands to lose significant tax deductions. Is this also an “aggregate incremental cost” that should be disclosed in proxy statements? Though loss of a tax deduction isn’t a “cost” per se, in an abundance of caution, some companies have been disclosing the fact (if not the amount) of the lost deductions as a result of personal-use flights. And, just to come full circle, if the deduction is a cost, receiving a tax deduction might be compensation, which is exactly what an old FAA interpretation concluded in proscribing flights by a tax-savvy operator who claimed they were conducted at “no charge.”

Even in this simplified account of a complicated subject, it’s apparent that companies face contradictory government standards in dealing with non-business flight expenses for employees and others that are certain to keep aviation lawyers and accountants busy for years to come.

Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.

Bizjet passengers often express confusion about when to give gratuities to pilots and crews. Here’s help. 

Bizjet passengers often express confusion about when to give gratuities to pilots and crews. Here’s help.

Should you tip your pilots? We hear this question often at Business Jet Traveler, so we did some research to help you know when to pull out your wallet.

We began by including questions about tipping in our third annual Readers’ Choice Survey, which drew responses from nearly 1,100 passengers. As we reported in our last issue, the greatest number (41 percent) said that they never tip, but 22 percent tip occasionally, 14 percent tip every time they fly, 13 percent tip frequently and 10 percent tip at the holidays in December. Of those who tip, 33 percent give more than $100, while 27 percent tip $25 or less.

One passenger we spoke with, who flies via a jet card, said, “It never dawned on me that you would tip pilots. I tip ground crew when they assist, but it seems strange to tip a pilot.” Another business jet traveler, on the other hand, said he goes out of his way to tip pilots. He added that they always appreciate it and that he has never seen a pilot who “felt in the least bit uncomfortable” about the gesture.

When is tipping appropriate? Unfortunately, no simple guidelines exist, but in surveying almost 100 pilots, we found that the type of flight makes a difference. Pilots who work in-house for corporations or individual clients seem to not expect gratuities. Some employers forbid their flight crews from accepting them, and some pilots find tipping offensive. In most cases, these pilots are well compensated by their employers.

“I get a good paycheck, a performance incentive [bonus] and stock options, just like the rest of the company,” remarked a pilot who asked to remain anonymous (as did most of those who spoke with us). “I have worked for three corporations and never expected a tip from passengers.”

For fractional and particularly charter pilots, however, salaries can be relatively low. Many pilots, even those who work for corporate flight departments, made a point of telling us that their brethren who fly charter should be tipped.

Charter pilots themselves typically say that they don’t expect tips but always appreciate them, especially for exceptional service. What constitutes ”exceptional”? If your charter pilot schleps 17 bags on your behalf, cleans up after your twin five-year-olds or prepares the cabin with lots of extras, you may want to offer a tip. As one pilot told us, “If I accomplish the flawless, multi-time-zone, multi-country, bureaucratic, hectic and maintenance-plagued mission with aplomb, a tip is a nice way for the passenger to show appreciation.” According to the pilots we surveyed, the average gratuity is $50 to $100 per flight per pilot.

Don’t worry if the charter company has a no-tipping policy. In the unlikely event that a pilot cannot accept gratuities or is uncomfortable doing so, he will undoubtedly still appreciate the gesture. And keep in mind that if you can’t say thank you by tipping directly, there may be another way. As one pilot commented, “Our company says ‘no tipping,’ but experienced passengers will say, ‘Have dinner on me.’”

What about tipping flight attendants and other onboard crew members? Joanne Cassar, a corporate flight attendant for nine years, said she believes that tipping is never expected or necessary, “but it’s always appreciated. It helps you to know that your service was good and the client is happy.” Cassar added that she shares her tips evenly with the rest of the onboard crew because she believes that she is part of a team.

Then there is the crew on the ground. Passengers and pilots do regularly tip line crew and baggage handlers, but there are exceptions. Maddy Gilad, chief pilot for Projet Aviation, an aircraft management and services company in Leesburg, Virginia, said that Projet usually builds into the cost of the flight tips for line people, handlers and fuelers and informs the passenger that the service is included. “That way,” she said, “the passenger can rest easy, knowing that all of those gratuities have been taken care of by us.”

In exchange for annual fees of up to $7,500, they offer benefits that even ultra-high-net-worth customers are likely to appreciate.

Before you began flying privately, you may have been that person who’d throw down your plastic at dinner and say, only half-jokingly, “Let me pay so I can get the miles.” Times have changed, and even if you still fly commercially sometimes, scoring frequent-flier miles probably ranks lower now on your list of priorities.

Nevertheless, some credit cards offer perks that even the highest-net-worth customers are likely to appreciate. First-class lounges remain essential if you use the airlines overseas (not much beats the Emirates lounge in Dubai with its spa services and sommelier), and the best credit cards will get you gratis access. Even better: a few cards offer concierge services that can rival the work of a personal assistant. 

One such card, the American Express Centurion, is made of titanium and available by invitation only and has no spending limit to speak of. Rumor has it that tech millionaire Victor Shvetsky purchased a business jet for $52 million on this card, which is also known as the Amex black card.

For a $7,500 initiation fee and $2,500 annually, card members enjoy perks that include preferred pricing on luxury exotic car purchases and dedicated concierge services to assist with everything from hotel arrangements to last-minute front-row concert tickets to personal shopping services all over the world. The card, which charges no foreign transaction fees, will also get you airline upgrades and access to the best airport lounges worldwide. (Contrary to popular belief, though, it won’t earn you membership in the “Gulfstream Aerospace Private Flyers Club”; in fact, no such club exists.)

Note to big spenders: we have heard of several cases where Centurion’s annual fee has been waived or reduced for cardholders with great credit who charge upwards of $150,000 a year.

Arguably even more exclusive than Amex black, J.P. Morgan Chase’s Palladium Card is made of palladium and 23-carat gold and features a smart chip for added security. Though the annual fee is a mere $595, there seems to be an unwritten rule that to qualify you must be a client of J.P. Morgan Chase’s private bank and have more than $25 million invested with the company. 

Once you pass that threshold, you can enjoy rarefied perks such as a 24/7 dedicated concierge service for travel, reservations and theater-ticket procurement and no spending limit. Also included in membership are complimentary airline companion tickets, first-class upgrades and access to most private airport lounges. According to Palladium’s 62-page brochure, card members will additionally benefit from insider access to Netjets flights through the Marquis Jet Card program.

The Citi Prestige card, which costs a relatively modest $450 annually, delivers many of the same benefits offered by Centurion and Palladium, including access to airport lounges and complimentary airline companion tickets (restrictions apply). Citi Prestige also offers price incentives at many luxury hotels and waived greens fees at more than 2,400 golf courses.n

Overall, jet buyers and sellers seem about evenly matched. But some models are in much greater demand than others.

Gazing through the rearview mirror at the first half of 2013, we see that, overall, the number of used jets for sale is neither rising nor contracting. Some models are a different matter, however.

In the light-jet category, for example, the Citation CJ3 seems to have become more popular over the past year. Last summer, you could choose from nearly 40, but the number on the market has since dropped to about half that figure, a level not visited since 2009. The downward trend may accelerate on the heels of Cessna’s announcement this past spring that it was reducing production of many of its light jets due to weak demand. Inventories typically grow in summer, but if CJ3 options remain limited, pricing could tighten in the fourth quarter. 

Meanwhile, the large-cabin segment seems a bit fickle. Inventory of the Gulfstream 450 had been flat in the second half of last year with only two sales. This year, activity finally kicked in toward the end of the first quarter and since then, six have sold, with others reportedly under contract. I’d be tempted to chalk up the lift in sales to the often-active spring buying season were it not for the Global Express market, which behaved in an opposite way and did the equivalent of an about-face. Only two have sold since the beginning of this year, yet in the previous six months five traded hands. 

While demand seems to be rising for the G450 and declining for the Global Express, neither has sold impressively over the past year. And because the large-cabin segment had long been one of the bright spots in an otherwise murky market, I’m left grasping for an explanation. Has much of the large-cabin buyers’ appetite been temporarily satiated? Are some models getting long in the tooth? 

Whatever the answer, there’s no question that buyers appear for any particular model once the price point meets their expectations; and while the pace of the slip in values may have slowed, it hasn’t stopped. Buyers continue to wield an upper hand. 

Bryan Comstock welcomes comments and suggestions at bcomstock@bjtonline.com.

It wasn’t until the end of the final quarter of last year that the used business jet market showed clear signs of direction. That’s when inventory moved noticeably lower after peaking at 2,600 in October. Just 60 days later, we were flirting with the 2,500 mark for the first time since the fall of 2008. 

The difference between that year and recent months is that in ’08 the inventory level was beginning its ascent to an all-time high whereas today supply is dwindling. In fact, if you focus on the sweet spot for buyers and bankers—the year-2000-and-newer collection—you see that worldwide inventory for sale is now below 9 percent.

In the recent past, activity has centered on the latest and greatest models, but demand for a wider assortment of aircraft is building. With airplanes like the Gulfstream G550, Challenger 300 and Falcon 2000EX already in short supply, attention is increasingly turning to some heretofore beaten-down, second-generation aircraft. The Challenger 604 is a prime example, with about half as many available now as there were a year ago. 

You may wonder why Gulfstream’s GIV-SP, with equally attractive pricing, hasn’t followed suit. I’ve been wrong for so long about this model’s recovery that I’m embarrassed to admit it. A year and a half ago, only 14 were for sale out of a fleet of just over 300, but then inventory began increasing. Today’s for-sale figure is 33—right about equal to the model’s 12-month moving average. There haven’t been this many GIV-SP choices since 2009. 

If you focus on 2000-and-newer aircraft that are based in North America, however, you see a different picture. Only eight GIV-SPs in this group (and just six 604s) are for sale at present and if the market continues on its current path, these could evaporate during the first quarter. 

Inventory has declined noticeably for some other models as well. Only nine Falcon 900EX EASy aircraft are on the market, for example, and Hawker 850XP choices have been halved since last summer, from 15 to seven. (And four of those are in Russia, Kuwait, Austria and Switzerland; only three are in the U.S.) If Citation CJ3 choices continue to dwindle, meanwhile, you may see the “Wichita Lineman” back on the line. Just over 400 are in operation, but supply has dropped from 33 last year to 23 today and appears poised to continue declining. 

While demand has risen for many models, there has not been any corresponding upward move in pricing. That may change this year for some models. No one seems ready to predict that, but the main complaint I’m hearing lately from my industry counterparts is that they need more inventory, and that’s a clear sign of a strengthening market. n

Bryan Comstock (bcomstock@bjtonline.com) is president of Jeteffect, a jet sales and acquisitions firm headquartered in Long Beach, California.

Business jet finance has settled into a predictable—and more sustainable—groove after the mad scramble of 2007 and the deafening silence of 2009. Here are eight realities of today’s market that you need to understand:

1. Banks still want to finance business jets. Though they aren’t giving away the store anymore, loans for business jet acquisitions remain available and financial institutions want to provide them. As an example, Goldman Sachs recently entered the market and, like Chase and Citibank, is seeking to finance jet acquisitions for its banking clients. In part, this demonstrates the durability of some core attractions of business jet finance: the ability to make a significant loan (Goldman is generally looking to loan $10 million and up) secured by good collateral with the credit backing of high- and ultra-high-net-worth borrowers.

2. The competition is cash.In this economy, an abundance of cash is waiting to be put to work. I recently asked an executive at a company buying a jet if it intended to finance the purchase, and the reply went something like this: “With $900 million of cash on our balance sheet, why would we borrow money?” Indeed, industry pundits estimate that cash accounted for approximately 65 percent of business jet buying power this past year. Of the remaining 35 percent, debt finance accounted for about two-thirds and leases for the balance.  

3. Interest rates remain low. Rates have inched up and down lately (depending partly on whether the federal government is shut down), but on the whole, business jet finance is cheap, and today’s low rates provide an incentive for aircraft buyers to lock in the cheap money while they can. Rates in the neighborhood of 2 to 3 percent for floating-rate deals (and a little more for fixed-rate deals) are pretty attractive, and no one expects them to trend downward. With the possibility of rates going up, aircraft owners are also reportedly showing more interest in refinancing existing loans. 

4. Down payments are the norm. Is 100 percent financing available? Yes, but much less so than in 2007. Depending on the financial institution, as an opening bid, jet buyers should expect to be asked to put down 10 to 20 percent. Years ago that would have seemed like a great burden, but many borrowers today have so much cash they aren’t fazed by down payments. There are signs that banks are loosening up. Greg Marks at First National Capital Corporation reports, for example, that his institution is showing greater flexibility in terms of down payments required and the length of the amortization period.  

5. Shorter terms may yield lower rates. Regulatory changes [see “The Changing Face of Aircraft Lending,” February/March 2013] will require banks to keep more capital on hand for longer-term loans (more than three years) rather than shorter-term ones. That provides an incentive for them to charge more for a seven-year note than for a three-year note, since the former ties up more capital.

6. Lenders are picky about collateral. As manufacturers deliver new aircraft, the old ones don’t just disappear. The sabre-tooth cat may be extinct, but the 1969 Sabreliner 60 remains available for purchase, as do such 1960s-vintage jets as the Gulfstream GII, Falcon 20-5 and Lear 23. Don’t expect your bank to help you acquire them, though. Banks typically want to finance relatively new aircraft, especially jets that are 10 years old or newer. 

Ironically, it’s not because the value of a GII could plummet tomorrow; on the contrary, relatively new aircraft like a G550 can shed $1 million or more in value each year, while values of GIIs from the late 1960s are holding steady. But the G550 is popular, whereas the average time to sell a GII during the last four years has been more than 400 days. No bank wants to have to foreclose on an aircraft like that, let alone lease it to a customer. 

In fact, many lenders (private banks, for example) won’t do leases at all, and those that do generally want the aircraft to be no older than 20 or 25 years at the expiration of the lease. That doesn’t mean you’re out of luck if you want to finance an older aircraft; it means you have to find the institutions that are willing to take on those projects.

7. Lenders are picky about customers.Changes in banking regulations will only further underscore the importance of the credit quality of borrowers. Banks will need to keep greater credit reserves to make aircraft loans to lesser credits, rendering those financings more expensive. The best aircraft deals will go to investment-grade credits with a longstanding relationship to the lender, assuming the lender doesn’t have too much credit exposure to the borrower already. That’s one reason it usually makes sense to start your search for aircraft finance by contacting your existing bank. Indeed, some banks are basically open for aircraft business only for their existing clients. Conversely, some financial institutions actively seek to syndicate their aircraft loans by selling pieces of them to other institutions.  

8. Financing will take time to close. That banks are pickier about collateral and customers goes hand-in-hand with another feature of contemporary aircraft finance: it can take a while to close the deal. Aircraft purchase contracts rarely have a buyer-financing contingency, so if the financing doesn’t come through in time, the buyer can find himself in an embarrassing situation. 

In a recent transaction, after months of document negotiations, the bank called the customer shortly before the aircraft was ready for delivery to explain that its outside counsel working on the deal had exceeded the cap on attorneys’ fees in the commitment letter by 300 percent. The bank refused to stand behind the cap, and (notwithstanding the bank’s contractual commitment) the customer had to pay most of the overage just to close the purchase. The outcome might have been different if the buyer had shopped for financing after acquiring the aircraft, when a lender can no longer say “you need my money to close.”

Jeff Wieand (jwieand@bjtonline.com) is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.

For some jet models, demand now exceeds supply.

Momentum from a strong finish in 2013 impacted the preowned business jet market in the first quarter of this year. Within just a few months, the number of aircraft for sale dropped about 10 percent, from 2,600 to 2,350. That’s a huge change.

It could be that buyers have finally responded to the declines of the past year, when prices of many models dropped to 50 to 70 percent of their peaks and millions of dollars in value evaporated. Some market segments may now be oversold.

The shining stars of the downturn have been Bombardier’s Challenger 300 and Gulfstream’s G550. Book values of the former have stabilized in recent quarters and the latter has seen significantly higher lows, with sale prices for early serial numbers moving closer to the $30 million mark. The Falcon 7X, meanwhile, is in short supply. The rate of sales among 7Xs seems lackluster, with one trading hands only about every two months, but that’s been enough to reduce inventory to about half of what it was a year ago.

There’s some heat in the formerly ­dormant super-midsize category. Only about 7 percent of the Citation Sovereign fleet—about a third less than a year ago—is on the market, for example; and availability is also down for the Falcon 2000 and Gulfstream G200.

Some hard-to-locate models are particularly difficult to find close to home. Consider the Citation CJ2. Not only has inventory shrunk—from 37 a year ago to 23 today—but just three of the currently available

aircraft are U.S.-based. (Nearly half are in Europe.) The decline in average prices—from around $3.5 million in 2011 to a little over $3 million last year and now $2.5 million to $3 million—appears to be ending, but any bump up will be only as much as the low end of the CJ3 market will permit.

Overall, the used jet business seems to finally be back on track and poised to continue on its current path as we approach one of the more active quarters.  

Bryan Comstock is president of Jeteffect, a jet sales and acquisitions firm headquartered in Long Beach, California.

Placing your aircraft in service for tax purposes isn’t as simple as it may seem. As one case demonstrates, you could pay a big penalty for mistakes.

To start writing off your newly acquired jet for tax purposes in the U.S. you have to do more than buy it; you have to “place it in service” in your business. In recent years, the availability of “bonus” depreciation has only upped the ante on satisfying this Internal Revenue Service requirement.

According to conventional wisdom, to place an aircraft in service, it’s enough to fly a few business trips. That’s obviously what insurance-agent-to-the-stars Michael D. Brown thought when he bought his factory-new Bombardier Challenger 604 in 2003. Unfortunately for him, the U.S. Tax Court disagreed.

Brown decided to buy the Challenger to take advantage of bonus depreciation, which would allow him to write off 50 percent of the $22 million purchase price against his 2003 taxable income. He signed a contract on December 16 and took delivery of the airplane in Portland, Oregon, on December 30, just in time to qualify for 2003 bonus depreciation. To cram in some business flights before year-end, he flew immediately to Seattle, ostensibly for a business lunch, and later that day took the aircraft to Chicago for another quick business meeting at a Midway Airport pizza restaurant.

The Tax Court’s description of these flights and of the factual inconsistencies in Brown’s accounts and records concerning them is dripping with skepticism. Moreover, Brown didn’t do himself any favors three years later when the IRS audited him and he asked the people he’d met with to sign backdated letters he wrote recounting the business value of the meetings.

But his biggest mistake was seemingly the most innocuous. Prior to closing on the airplane, Brown signed a work order with Midcoast Aviation, which had completed the aircraft, to install a conference grouping and larger display screens, both of which he steadfastly maintained were needed for his business use of the aircraft. Promptly after his hectic end-of-year flights, the Challenger returned to Midcoast for the additional work.

Brown no doubt emphasized that his business necessitated the post-closing installations because he wanted to make sure that the $500,000 cost of the improvements would be tax-deductible. In doing so, he shot himself in the foot, for the Tax Court concluded that, if the installations really were necessary, then the aircraft wasn’t ready to be placed in service for Brown’s business use in 2003, and he wasn’t entitled to commence depreciation for tax purposes that year.

According to Brown’s own testimony, the court observed, “his insurance business required that the airplane have a conference table and the larger screens so he could make his PowerPoint presentations to clients and other agents—and those presentations were not a peripheral part of his business.” Even though he had arguably used the aircraft in business in 2003, he failed to place it in service that year because, until the modifications were completed, the aircraft was not “ready and available for full operation on a regular basis for its specifically assigned function” and thus “wasn’t sufficient to meet his specific business needs.”

The Tax Court was clearly determined to hang Brown, who reportedly settled with the IRS for $20 million in back taxes and penalties. But the case also sheds light on what it takes to start the IRS depreciation clock ticking on an aircraft by “placing it in service.” In the 1966 Sears Oil case, a barge was delivered to the taxpayer before year-end, but the taxpayer couldn’t make business use of it until the following year because it was frozen fast in an icy canal. The court allowed tax depreciation to commence in the year of delivery, noting that deterioration of the barge had already begun and that the taxpayer was prevented from using the boat by circumstances beyond its control.

Citing Sears Oil, the Brown court concluded that “it’s possible for a taxpayer to place an asset in service for a certain tax year even without using it that year.” However, to be considered as “placed in service” in a given year, the court said, the aircraft must be “available for its intended use on a regular, ongoing basis” that year, though circumstances beyond your control may prevent you from using it.

Does this mean you can dispense with those business flights that aviation lawyers make their clients take every December after their aircraft are delivered? Hardly. Unless your aircraft is frozen in a canal or the like, it’s still important to fly it for business purposes in the year you take delivery. But don’t send an administrative assistant from the New York office to deliver a package to the Philadelphia office on December 31 in your brand-new Gulfstream G650 and call that your business trip. On the contrary, the business flights should be genuine, involve company personnel that would be typical passengers and be the kind of trips you would use the aircraft for. And the more flights the better. Brown also illustrates the importance of accurate and contemporaneous documents and records regarding the business flights.

The key message of the case, though, is that the IRS will be looking to see whether the aircraft is capable of fulfilling your specific business functions. Suppose, for example, that the main reason to purchase a business jet is to ensure that the CEO is in touch with the company at all times while traveling. You will be hard-pressed to show that that business function was met in the year of delivery if telephones and Wi-Fi weren’t installed until the following year.

Finally, be realistic about the value of taking depreciation on an aircraft, the benefit of which is simply the time value of money. The advantages of bonus depreciation, for example, are often overestimated, especially if an aircraft’s availability for super-accelerated tax write-offs drives up the price. Brown was so desperate to get bonus depreciation in 2003 that he bought a jet with the wrong interior in December only to put the aircraft down a few days later for a $500,000 retrofit in January. The opportunity cost on $22 million probably added at least another $100,000 expense. Tax benefits are important, but it’s worth considering all relevant factors before allowing them to determine your aircraft purchase.

If your aircraft requires repair after an accident, your insurance should cover the bill. What it won’t cover is the diminution of value that results from a history of damage. 

What’s the worst thing that can happen to your business jet? You might think the answer is an accident resulting in total loss, but it’s not. If a hangar roof collapses and destroys your aircraft, your insurance should enable you to replace it. On the other hand, if the airplane is only damaged in the incident, the insurer may opt to repair it, leaving you with a jet that operates just fine but has (gasp) damage history.

Everybody in business aviation has a favorite damage-history story. There’s the Hawker 800 that was carrying the president of Rwanda when a missile hit it, blowing one of the engines off the pylon. There’s the GV that was parked on a ramp on a hot day and sank a foot into the tarmac. My favorite is the Falcon 900 that, while landing near a golf course, was hit by a golf ball that lodged in the fuselage. 

All three of those airplanes—even the Hawker—returned to service, but to varying extents, the incidents affected their value, and it’s not hard to see why. If two identical airplanes are priced the same and one of them had the vertical stabilizer shaved off and repaired while the other has no damage history, which would you buy?

Aircraft owners sometimes assume that their insurance protects against diminution in value as a result of damage, but the truth is that hull insurance seldom covers this. You can buy diminution-of-value coverage, but according to Stuart Hope of Hope Aviation Insurance, aircraft owners rarely purchase it due to its high cost relative to the limited perceived risk. As noted earlier, hull insurance should cover the repair of damage, and that cost is readily identifiable by getting quotes from repair stations. Loss in value, on the other hand, is difficult to pin down and can be hidden or even extinguished by external circumstances. If an aircraft was damaged in late 2008, when business jet values plummeted across the board, it would be hard to say how much of the loss in value resulted from the damage incident rather than market forces.

 “The first question is whether the aircraft was ‘passive’ or ‘operating’ at the time of the incident,” says veteran business jet appraiser Bob Zuskin, when asked how he determines diminution of value caused by damage. All other things being equal, an incident that occurs in flight or on landing, for example, is more serious than something that occurs while the aircraft is parked in a hangar. Zuskin, the founder of Virginia-based Jet Perspectives, notes that market conditions make a big difference in valuing damage history. In today’s environment, “every incident has some ramification,” he says. 

Even if your insurance doesn’t cover diminution in value, it doesn’t mean you can’t recover from somebody. If the aircraft is damaged in the hangar, you may be able to hold multiple parties responsible in court, but if the damage results from natural causes, like a bird or lightning strike, you’re basically out of luck unless you have the insurance.

Because $25 million of hull coverage doesn’t cost that much more that $20 million, many jet owners are tempted to insure their aircraft for a good deal more than they’re worth. You should resist this temptation. It is better to over-insure a bit rather than purchase too little hull coverage, but if you get greedy, your insurer will have a strong incentive to repair a seriously damaged aircraft rather than write you a check for 100 percent of the hull coverage. 

Given the impact on value, checking for damage history is one of the most important parts of the due diligence you should perform when buying an aircraft. But even if it has no history of damage, the airplane can be damaged between the time you agree to buy it and when you close the deal. A purchase contract normally gives the buyer the right to terminate the transaction if the aircraft suffers damage or if previously undisclosed damage is uncovered. The problem is, how do you define “damage”? Does the buyer really get to walk away from the deal if someone accidentally scratches the wood veneer during the prebuy inspection? To answer this question, aviation lawyers frequently turn to the definition of “major repairs” in Appendix A to Part 43 of the Federal Aviation Regulations, the criterion for issuing the dreaded FAA Form 337, which details major repairs and alterations.

Damage history is particularly tragic when it occurs prior to delivery of a beautiful, brand-new business jet. Every manufacturer can share horror stories on that subject, like the one about the aircraft that was pelted by a hailstorm while flying to the closing location. Here again, the contract should allow the buyer to terminate, perhaps with the right to acquire the next available aircraft from the manufacturer on comparable terms. But many new-jet contracts also give the buyer the opportunity to acquire the damaged aircraft (after it has been repaired, of course) and be reimbursed for the diminution in value caused by the damage. Buyers should be careful, though, if the repairs require burdensome recurring inspections or if warranty protection may be inadequate to cover potential future issues.

Damage incidents are more common than you might think. On average, business jets get hit by lightning every seven to eight years, and “hangar rash” occurs all the time. Even when damage is significant, how it is repaired and by whom has a big impact on how it is perceived. 

One thing everyone agrees on: diminution in value as a result of damage diminishes over time. What seems like a major problem today will be less of an issue after the aircraft flies around for a few years. 

Important Criteria in Evaluating Aircraft Damage:

Did the damage occur in flight?

Did it occur while the aircraft was in motion (e.g. taxiing)

Who repaired the damage?

How was it repaired? Was a part simply replaced with a new part?

Was an FAA Form 337 issued?

What does the logbook entry say?

Are any non-standard recurring inspections required as a result?

How long ago did the damage occur?

With demand high for late-model jets, bargain hunters may start looking more at older aircraft. 

When you’re evaluating the state of the used-aircraft market, you need to look at more than the percentage of the worldwide fleet that’s currently for sale. You have to investigate availability in a variety of geographical areas and model-year ranges.

Consider that only 8.1 percent of the nearly 11,000 airplanes manufactured since the beginning of 2000 are now for sale. Meanwhile, the percentage of older aircraft on the market is about twice as high. A disparity also exists between the two areas of the world with the largest late-model business jet population. North America has a tight supply of airplanes manufactured since the beginning of 2000, with only 6.5 percent for sale, but Europe’s market still languishes with twice that figure available. 

The spread between North America and Europe has remained fairly consistent over the last couple of years, but may be in for a change as the European Central Bank contemplates something similar to the Federal Reserve’s quantitative easing. While one may question the wisdom of these types of programs, it’s a fact that fewer aircraft are for sale today than before the U.S. initiated its current monetary policy. 

The continued short supply of late-model jets should spur new-aircraft sales but may also cause preowned-jet buyers to look more at older airplanes. While popular 2000-and-newer aircraft like the Falcon 2000EXy and Challenger move at a rate of about one a month, pre-2000 models currently often sell at a one-per-quarter rate, despite seven-figure price drops in some cases.

We’re still witnessing the upbeat buyer activity that descended on the market in the fourth quarter of last year. In fact, inventory is now at its lowest point since the fall of 2008 and is noticeably below its 12-month moving average. This is likely one reason we are starting to see values stabilize across many model segments. 

Bryan Comstock is president of Jeteffect, a jet sales and acquisitions firm headquartered in Long Beach, California.