AINalerts: When Bizjet Buyers Make Costly Errors

As I considered topics for my milestone 50th blog in AIN, I decided to share stories behind real jet purchases showing how clients have made avoidable mistakes in their aircraft selections, regulatory structuring and implementation, and/or tax planning. Their errors cost them millions of dollars, disrupted their travel, or entangled them with the FAA. As I have said before: Do not embark on the journey to purchase an aircraft without a qualified aviation team supporting you.

A client wanted to buy a jet quickly (aircraft 1) so he could go on a fishing trip with his friends. In rushing to close the deal, the client sacrificed most of the standard aircraft due diligence. Within a few months, the client returned with a plan to buy a different aircraft (aircraft 2) because aircraft 1 apparently did not meet his needs. He eventually sold aircraft 1 at a loss of hundreds of thousands of dollars.

Astonishingly, a few months later, he returned again with a new plan to buy a different aircraft (aircraft 3), as aircraft 2 apparently did not work for him either. He eventually sold aircraft 2 at a significant loss. The third time was the charm, but at a high cost in money and time.

Perhaps an even worse scenario, early in the pandemic aircraft-buying frenzy, a technology CEO bought a large-cabin business jet for cash at an elevated price. Realizing the error of his ways, the CEO never flew the aircraft, though he owned it for a year and then needed to sell it.

Compounding this problem, he also needed to “refinance” the aircraft (extract its equity) to fund his nascent business. For at least six months after closing the loan, he paid a high interest rate on top of transaction costs and loan fees. When he sold the aircraft, he lost nearly $2 million, including $600,000 for undiscovered repairs found during a later pre-buy inspection and expenses to unwind the financing.

Takeaway: Define your mission and full budget, as a purchaser and owner, before signing a letter of intent (LOI). Do not let your emotions drive your purchase decision. Do not cut corners on customary due diligence without compelling reasons based on market and risk analysis from an experienced aircraft broker, technical consultant, and aviation lawyer who can guide you through the process.

Closing deals at a fast pace is almost routine, but a speedy closing is not a strategy. Like any other deal, if you can't make sense of a purchase, walk away, especially if you are a first-time buyer.

WHEN YOU DO NOT PROPERLY STRUCTURE OWNERSHIP AND FLIGHT OPS

The legal foundation of U.S. business aircraft purchase transactions is regulatory compliance with the FARs and other FAA rules. Clients typically operate under FAR Part 91 (private flights) or FAR Part 135 (charter flights).

Amid this mind-bending regulatory morass, you should rely on your aviation team to proceed into other key aspects of each purchase, including the purchase transaction terms, tax planning, liability risk management (including insurance coverage), financing or leasing, privacy, and aircraft management.

In many transactions, a client forms an LLC to own the aircraft, an acceptable, although not always useful, structure. However, many LLC members ignore or blatantly violate the FAR by using the LLC to operate the aircraft with at least one crewmember (a wet lease) for flights paid for by the members or third parties.

Presto, amid the very few bright-line rules in the FAR, the LLC morphs into an illegal “flight department company”—plain and simple. Because the LLC has no business other than operating the aircraft it owns, it lacks the authority to do so under FAR Parts 119 and 135.

Consequently, the FAA may take legal enforcement actions, including imposing civil penalties on the owner or related entities and/or seeking punitive “certificate” actions against the pilot(s). Not to be left out, insurers may deny coverage, in general, due to misrepresentations, policy limitations, or policy violations by their insureds arising from the non-compliant structure. Finally, the LLC may not shield the member from personal liability, a main reason purchasers create an LLC to own the aircraft.

Frustratingly, in one situation, a client refused or neglected to use an appropriate dry leasing structure to comply with the FAR through leasing of the aircraft without crew (dry lease) to himself or other qualified operators under FAR Part 91. He said that his buddy had for years used the LLC for flights without ever seeing the FAA. The client, who seemingly followed his buddy’s lead, was not so lucky.

A few years later, the FAA conducted an unannounced inspection of the client's operations. The client could not demonstrate its compliance with FAR Part 91 or 135. The FAA discovered that the client had been operating, for years, as an illegal flight department company. To the FAA, the client appeared to be the poster child for illegal charter, justifying an FAA certificate action against the pilots and a civil penalty action against the client, resulting in the revocation of the pilots’ certificates and the imposition of millions of dollars in civil fines on the client.

Takeaway: Given that the FAA has vast powers and an unlimited legal budget, and now even more aggressively searches for and punishes illegal charter operators, it makes no sense to play “Russian Roulette” involving the FAA or incur high costs to defend against FAA sanctions, especially compared to using relatively inexpensive and legally compliant ownership structures.

Owners and pilots should not rely on other owners who may have faulty knowledge of, or an unwillingness to comply with, the FARs, or who have been lucky enough to fly under the FAA’s radar.

WHEN A PURCHASER MISUNDERSTANDS TAXES

Although clients almost universally ask me to structure bonus depreciation into their deals, extended and made permanent under The One Big Beautiful Bill, it seems few of them actually qualify for the tax benefit.

One client, like many others, presumed that, after a liquidity event (selling his business), he could ease his monster tax burden on his sale proceeds by purchasing a large-cabin, $22 million jet. He believed that, once he took the depreciation, he could operate the aircraft under Part 91 primarily for personal reasons and sell the aircraft in a few years without any income tax consequences.

In counseling the client, I first asked whether he would purchase the aircraft if he could not claim bonus depreciation. In his case, the client said he would not purchase the aircraft. Spoiling both his day and mine, I had to inform him that his liquidity event and intended aircraft use precluded him from claiming bonus depreciation. So we moved beyond that subject to find other forms of tax relief.

Other misunderstandings occur in the sales tax sphere. Clients often believe they do not have to pay sales tax (or an equivalent) anywhere when they close in a “flyaway” state like Kansas. A flyaway exemption allows a purchaser to buy an aircraft without paying sales tax in the state where the purchaser takes delivery, provided the purchaser meets the state’s exemption requirements.

This misunderstanding resulted in a costly error for a large company that purchased a $43 million jet in a flyaway state to avoid sales tax. The client’s internal tax department managed all tax matters, including the preparation of the Kansas flyaway certificate used in the closing.

Many months after closing, the company called to ask whether they still had a sales tax obligation for the aircraft purchase. Their timing worked against the company, as it had become subject to a $2 million use tax payment obligation. A use tax may be payable for aircraft purchased outside a state, but applies if the owner “uses, stores, or consumes” the aircraft in a different state with a use tax (such as Texas). The client apparently believed that the flyaway meant it paid no sales tax to anyone. The tax outcome remains a mystery.

Takeaway: Plan for taxes (including exemptions and deductions) before you sign an LOI. Remember that taxes arise from state and federal income taxes (or the equivalent), franchise, state sales and use taxes, property taxes, tariffs, and other tax obligations. Engage aviation tax accountants and qualified aviation/tax lawyers, as aligning regulatory compliance and tax planning is complex.

LAST THOUGHTS

In this blog, I have shown that in just a few purchase deals, purchasers lost millions of dollars by choosing the wrong aircraft for their missions, failing to structure their purchases to comply with the FAR (or refusing to implement the correct structure), and making bad assumptions about their tax situation. Unfortunately, the clients’ decisions led them into regulatory violations, unexpected taxes, and other challenges in purchasing and owning their jets. The main takeaway should be, as I like to say, “do it once, do it right” when you purchase an aircraft.

This marks my 50th consecutive blog published in AIN since 2018. More recently, AIN sister publication Business Jet Traveler (BJT) has also published a version of these blogs. Thank you for your continued readership and kind comments, all made possible thanks to AIN and BJT.