Story ID: 
AINsight: Five Leases Power Bizjet Deals
By: David G. Mayer
Caption: Business aircraft buyers can miss out on the potential tax, financial, and other advantages of leasing as an alternative to cash or financed purchases.
Word Count: 1764
Business aircraft buyers regularly miss out on the potential tax, financial, and other advantages of leasing as an alternative to cash or financed purchases. Some owners may not know they need to lease their aircraft to comply with FARs, while others shun leasing as unnecessary or burdensome.
Yet many first-time and repeat aircraft purchasers use financing and leases or both for valid economic and regulatory reasons. The most significant leases used in business aviation consist of dry leases, wet leases, operating or “true” leases, tax leases, and financing leases. Amid these leases, one works like a loan.
Loans and Leases at a High Level
A lease of a business aircraft under the Uniform Commercial Code (UCC) generally means a transfer by a lessor to a lessee of the right to possess and use an aircraft for a term in return for consideration—usually hourly, fixed, or variable rent payments. The lessee is the party using the aircraft under the provisions of a lease, and the lessor is the party furnishing the aircraft under a lease. Most lessors pay 100 percent of the aircraft purchase price to buy and then lease the aircraft to a lessee. 
Lessors usually structure leases as “net” leases, where the lessee agrees to broad maintenance, tax, insurance, and other obligations relating to the aircraft. Lessors have different business models that affect pricing a transaction.
In some sale-leaseback deals—a form of cash-out refinancing for existing owners—lessors also pay 100 percent of an agreed purchase price to buy the aircraft from the owner and then lease it back to the owner. In both leasing transactions, lessors usually assume a residual value that may lower rent payments. Residual value refers to the market value of an aircraft at the end of a lease term. A lessor projects a residual value that maintains its return. 
In a traditional financing transaction, borrowers use loans to purchase or refinance aircraft. A secured loan occurs when a lender advances funds to an owner—borrower with repayment supported by an owner’s grant of a security interest in the aircraft under a security agreement or aircraft mortgage.
Lenders typically loan about 70 to 85 percent of the lower of the aircraft’s appraised value or purchase price, called the loan-to-value (LTV) ratio, over a term of five to seven years. Borrowers pay the unfinanced balance of a purchase price in cash or leave equity in an owned aircraft in a refinancing deal. Of course, some lenders and lessors adjust terms and LTV to fit their business models and serve their customers’ needs.
Lease/buy Decision
After finding the right aircraft, the threshold money issue is whether to lease or buy the aircraft. Most buyers pay cash—the bane of aircraft financiers’ existence. Others use leases or loans discussed here. Although cash purchasers avoid lender/lessor requirements, lenders/lessors will negotiate most terms.
To make an informed lease or buy decision, the acquirer’s aviation team should analyze, among other criteria, the transaction economics on a pre-tax and after-tax basis. For example, the parties can solve for the higher value to a purchaser of the amount of cash flow (pre-tax) paid for principal and interest loan payments versus rent payments and the value after applying applicable tax deductions attributable to rent and interest payments (after tax). 
Organizations reporting under the rules of the Financial Accounting Standards Board (FASB) should evaluate the current lease accounting standard, FASB No. 2016-02, Leases (Topic 842), which no longer permits lessees to keep leases “off balance sheet” except for leases with a term of 12 months or less.
Dry and Wet Leases
Under FAR 91.23, “a lease…[means] any agreement by a person [that]…furnish[es] an aircraft to another person for compensation or hire, with or without flight crewmembers, that is not a contract of conditional sale.” The FAR categorizes a lease into two types: dry leases and wet leases.
How can you decide whether a transaction constitutes a dry or wet lease? The key is to identify the person (operator) who has “operational control” of the aircraft; this is the person truly responsible for the flight. FAR 1.1 defines operational control as “the exercise of authority over initiating, conducting or terminating a flight.” The operator has front-line personal liability exposure whether operating under FAR Part 91 or 135.
A dry lease is a lease by a lessor to a lessee where the lessor transfers the use and possession of an aircraft without crew to the lessee. Under FAR Part 91 non-commercial operating rules, a lessee under a dry lease must independently hire crewmembers and exercise and maintain “operational control” of the aircraft, akin to renting a car. 
Meanwhile, a wet lease is a lease by a lessor to a lessee where the lessor transfers the use and possession of an aircraft, including at least one crewmember—like traveling by taxi. Under a wet lease, the lessor maintains and exercises operational control of the aircraft.
Unlike Part 91 dry leases, lessors in wet leases must obtain an operating certificate under FAR Part 119 and comply with rigorous crew training, crew rest, weather, drug testing, maintenance, and other safety rules under FAR Part 135 nonscheduled commercial operating rules.
A limited liability company (LLC) that owns an aircraft but has no other purpose must ensure it complies with the FARs. This type of LLC may dry lease an aircraft to a few operators under Part 91 or enter into a charter lease with an air carrier under Part 135.
However, suppose such an LLC exercises operational control, purports to wet lease to another person, or dry leases to a large group of unrelated lessees under Part 91. In any of these arrangements, the FAA could view the LLC as conducting illegal charter operations, treat the LLC as a prohibited “flight department company,” and take enforcement action against the violators. The FAR does not permit wet leasing under Part 91 except for, among others, timesharing and interchange arrangements.
Operating/True Lease
An operating lease or true lease is a type of FAR-compliant lease agreement, which may also be a dry or wet lease. It is not a financing lease, loan, or conditional sale. Lessors provide 100 percent funding to purchase an aircraft from a seller or the owner-seller. But lessors may not price in depreciation even if the lessor can use the depreciation.
The lessor will require the lessee to return the aircraft to the lessor at lease expiration in a specified return condition. Using this type of lease, lessees can manage obsolescence and facilitate fleet planning. A lessee should evaluate whether it can deduct the rent it pays to the lessor.
Tax Lease
A tax lease or “true tax lease” refers to an operating or true lease that conceptually aligns with, but may deviate from, the U.S. Internal Revenue Service (IRS) Rev. Proc. 2001-28 leasing guidelines and comply with federal tax law. Normally, the lessor is a finance company or bank with a tax appetite to use all or part of the depreciation deductions.
The lessor is the tax owner of the aircraft. Under the IRS guidelines, a lessor must maintain a residual value risk of at least 20 percent of the aircraft’s original cost and assume a useful life at lease expiration of at least 20 percent of the aircraft’s original useful life. Like a true lease, a lessee may be able to deduct the rent it pays to the lessor.
On Jan. 1, 2023, bonus depreciation steps down from 100 percent to 80 percent for new and used aircraft, making timing critical in tax planning and taking title to an aircraft. A tax lease enables the owner/lessor to take and pass a portion of the bonus depreciation to a lessee through lower rents if the lessor agrees. 
Financing Lease
A financing lease is a type of loan that differs from other leases. Financing leases take other names such as a “disguised lease,” a “$1 out lease” (meaning the last payment to take full title is $1), or a “lease intended for security.” Regardless of the form of, or labels on, documentation, this lease refers to a secured transaction under UCC Article 9 that includes a nominal purchase option price. 
In FAA terms, such a lease may be a “conditional sales contract” if the lease contains a purchase option equal to not more than 10 percent of either the lessor’s costs (if newly acquired) or the value of the aircraft at the time of the lease. In those cases, the lessee files at the FAA Civil Aircraft Registry as the registered owner. A financing lease is probably a dry lease, too.
Final Points 
When acquiring a business aircraft or complying with the FARs, lessors may incentivize potential lessees by offering a wide range of leasing products and solutions. Lessors can customize a lease term, coordinate the rent payment schedule to a lessee’s cash flow, facilitate the use of bonus depreciation, and even prevent a company from engaging in illegal charter operations. The decision to lease or buy an aircraft is not always obvious, but the potential benefits to the parties make their efforts worthwhile.
David G. Mayer is a partner in the global Aviation Practice Group at Shackelford, Bowen, McKinley & Norton in Dallas, which handles worldwide private aircraft matters, including regulatory compliance, tax planning, purchases, sales, leasing and financing, risk management, insurance, aircraft operations, hangar leasing, and aircraft disputes. Mayer frequently represents aircraft owners, flight departments, lessees, borrowers, operators, sellers, purchasers, aircraft managers, and lessors and lenders. He can be contacted at dmayer@shackelford.law.
The above content is intended for informational use only and does not constitute legal advice or create any attorney-client relationship. Each person involved in these transactions should consult his or her aviation team advisors. Additionally, the opinions expressed in this column are those of the author and not necessarily endorsed by AIN Media Group.