FAMILY OFFICE INSIGHTS

Private aviation for Family Office advisors

If you're interested in learning how private aviation can offer greater flexibility and security, please listen to our recent webinar. SVB Private Executive Vice President Bill Woodson and industry experts Don Dwyer, Managing Partner, Guardian Jet, and Keith Swirsky, President, GKG Law, discuss the latest benefits, logistics and costs of private aviation.

Families interested in flying privately have many items to consider such as ownership options, fixed and variable costs, aircraft selection, taxes and staffing. Our speakers covered these topics to ensure you understand their impact as you consider private aviation.

During the webinar our speakers discussed:

  • The many ways you can now access private aviation.
  • The current costs of aircraft ownership, including fractional shares and membership fees.
  • A real-world comparison of private and commercial aviation.
  • The pitfalls to avoid when acquiring business aircraft.
  • Critical tax considerations and strategies for mitigation.

Speakers

Bill Woodson, Executive Vice President, Head of Wealth Advisory and Family Office Services, SVB Private

Don Dwyer, Managing Partner, Guardian Jet

Keith Swirsky, President, GKG Law


Audio transcription

Bill: Hello, everybody. Thank you for joining us today. I'm Bill Woodson, Executive Vice President and Head of Wealth Advisory and Family Office Services at SVB Private, and welcome to our webinar. Today, we will be discussing many items families who are interested in flying privately should consider, including ownership options, fixed and variable costs, aircraft selection, taxes, and staffing. Our speakers will cover these topics and ensure you understand their impact as you consider private aviation. I'm joined by two experts in the field of private aviation. First, we have Don Dwyer, co-managing partner at Guardian Jet. Don spent most of his career rising through ranks at aircraft manufacturer Hawker Beechcraft. As their vice president of Global Sales, he led the entire sales team, and oversaw the company's international dealer network. In 2010, Don joined his brother Michael as co-managing partner at Guardian Jet. Since then, Guardian Jet has become one of the top three aircraft brokerage and consulting firms in the world.

Keith Swirsky is president of GKG Law, and chairman of the firm's Business Aviation Group and Tax Group. With more than 36 years of private law practice experience, Keith has marshaled extensive knowledge of federal aviation tax, commercial law and regulatory issues. Today, GKG Law is one of the leading practices in the world, primarily devoted to aircraft acquisition and sales, federal and state taxation, federal and state tax audits, and financing.

We are happy to take any questions you may have. Feel free to submit them throughout our discussion today. And while we will be answering these questions during a formal Q&A period at the end, given that the topics will be shifting, feel free to ask them throughout, and I will endeavor to interject and ask the question that's relevant to where we are in the discussion. Now I'll turn it over to Keith, to kick off our conversation.

Keith: Thank you, Bill. Go to the next page. Next page.

Thank you. Thank you for that introduction, Bill. It's a pleasure to be here. You've already covered several of the areas that I wanted to mention about GKG Law. What I would also add, for the audience, is that at GKG Law, since I've started the business aircraft group back in, I want to say 1990, in the late '80s, we have conducted over 4000 aircraft transactions. I have been involved in pretty much all of those deals at some level, certainly when it comes to the tax structuring and planning, I typically do all of that. We have a fairly deep group of lawyers that can handle purchase and sale documentation, federal and state tax audits. We also handle personal use calculations in-house, so we do the determination of what is allowed and disallowed as write-offs for those calculations. We handle setting up trusts. Basically, the overall soup to nuts structuring of the transaction. Frankly, everything except what Guardian Jet, in this case, of Don's company, would do in their role, from the transaction. And we'll get into that, what the steps in the transaction are in this presentation.

Before I hand it over to Don to brief you on what Guardian Jet does, I'll just mention what we're going to cover in the presentation. So, we'll highlight, first, Don and I will get into highlighting what the available market options are. We'll talk about numbers as well. We'll spend a fair bit of time on numbers, with respect to those various market options. Then we'll get into covering what the steps are, and Don and I will interplay on the steps to conducting a successful aircraft transaction. Then when we complete that, I'll get into some tax. I'll talk about the lender case, which is the leading case in the family office area, and what I would consider to be the gatekeeper and primary Internal Revenue Code sections, at a high level, that will dictate your ability to take maximum deductions, and the limitations on the ability to take maximum deductions with respect to the acquisition of an aircraft or any other type of aircraft product that we discuss on the webinar. And as Bill said, we're happy to take questions while we're discussing the topic and to answer those during those slides, as well as questions at the end of the webinar as well. So I'll turn it over to Don.

Don: Thanks Keith, and thank you, Bill, for the opportunity to address this audience. If I had to describe Guardian Jet in one sentence, I'd say that we earn the right to transact purchases and sales of aircraft for the most sophisticated clientele in the world through providing great information. First we're a consulting company, and then a brokerage. I like to say there are five pillars to our business. The first pillar would be valuation. A long time ago, we decided that understanding value is a core competency, and we wanted to do that across the spectrum of aviation, from very light jets, even the small turboprop that we fly, all the way through the largest corporate jets. So we have a valuation model that we use that I think has become the clearinghouse for pricing in the industry. Most of the OEMs use it. A lot of the larger banks use our information on pricing and what's going on in the marketplace.

The second pillar of our business is the consulting. And if you think about consulting, we are not operational consultants. We don't go into a flight department and tell them how to operate more safely. We can help you set up a flight department, and certainly choose a management company. That's something we do every day. But our real consulting business is built around capital planning. So, for everything from the world's largest customers, Walmart and Shell, and almost 40% of the Fortune 100, we help with capital planning, 10-year plans on airplanes flown in and out of their fleets. But also, we do an enormous amount of consulting for people that fly 100 hours a year, that helps them with the math. Should I own an airplane? If I own it, should I charter it? Should I just charter? What are my options, etc., some of the things we're going to talk about today. And our consulting business is built around that.

The third pillar of our business is acquisitions. We, because of our Fortune 100 customer list, we are the biggest buyer of new airplanes in our space, by a lot. We also buy used airplanes every day for high net worth individuals. Fourth pillar being sales. We're, I like to say my brother and I are in our fourth decade peddling airplane, so I hope we're okay at it. We have a different process for it than at other brokerages, and if you're interested, we'll get into that later on, or in a subsequent meeting.

The last thing is what I call accessibility, the last pillar. We have some tools, we believe in transparency, and so we have tools that help our customers understand the marketplace. So we give them access to more information than a normal brokerage would. We let them know what, where airplane prices, what airplanes are selling for, what they look like, and so, we make all our information available to our customers 24/7, through a portal we call the Vault. So, that's Guardian Jet in a nutshell. I think we're the first guys to marry consulting with transactions at a level that we have. If we're one of the two or three largest brokerages in the world, there's three of us that are pretty good size, I promise you, we're the largest consultant in the space on capital. So, that's us. Thanks Keith.

Private aviation options (8:30)

Keith: Thanks, Don. All right, we'll go to the next slide. Okay. So, for those familiar with the aircraft marketplace, this may look familiar. When you get into private aviation, usually it's through on-demand charter. That's ad hoc. You, many people, get into it through a charter broker or they contact an aircraft charter and management company directly, if they have information as to who those players are in their local geographic market, and you buy a flight on a one-off basis. You specify the type of plane, you specify where you're going, and, you know, the date and time, and the plane shows up and you get billed for that particular flight.

It's ad hoc. It's a lot of work to schedule it if you're a repeat flyer, so once people get into regular flying, on-demand charter tends to be something you want to move away from, and people will move into the possibility of a jet card or a membership program. There's no ownership of an aircraft with a jet card or a membership program. A jet card is really just a bundled group of hours, 25 hours, 50 hours. It could be on a particular plane, it could be on planes where you're allowed to choose your cabin class size. Membership programs can be very similar. Again, it's no different than a jet card. It's just that one's called a card, one's called a membership program. At the end of the day, you don't own an asset, but you have what is much... More than on demand charter, you have more consistency of product, all right, more rules associated with how you schedule, and more consistency of what your expectations are.

Fractional ownership can be purchase of an actual asset, as a tenants in common. So you have a, whatever, say, a 10% tenants in common ownership interest in an aircraft. You could also have a leasehold interest. So, fractional programs offer both products. So, to a degree, they're really offering you an iteration of a jet card, or an iteration of a membership program if you lease with them. If you buy with them, you have ownership. Either way, it's, again, a very, what I would call contrived structure. They have huge contractual rules and regulations that govern your use and operation of an aircraft. It's consistency of product, it's consistency of service, and you get into that when your, again, your usage of an aircraft goes up in hours.

Now, if your usage continues to go up, you might get into shared ownership, which is where you would actually purchase a whole aircraft with one or two other individuals or companies, and manage that plane yourself, or use a professional management company to manage that aircraft. And then lastly, when your usage goes even higher, or your scheduling is such that you can't get into shared ownership, you would get into full ownership of an aircraft. And again, that's very straightforward. You would own an entire aircraft. That could either be through your direct titling or through bank financing, where you have a capital lease. Excuse me, an operating lease. And again, you need to manage that aircraft yourself, or you'd go to a professional management company to manage that plane.

So those are, sort of, at a high level, the various, as you move up from a very low level of use to a high level of use per year, your options. Are there any questions on this slide, Bill? If not, we can go to the next slide.

Don: You know, I'd just add a couple things, Keith.

Keith: Sure. Yeah.

Don: I think that this progression has changed dramatically in our careers. So, when I started in aviation, there was pretty much on-demand charter, and then you own an airplane. The great news about the progression that people go through now is their very sophisticated, really high-level experience when you get, especially when you get into the fractional shared ownership or full ownership, and to some degree, the jet card program can be. So I love to say that people are being introduced to aviation at an extremely high level right now. There's some statistic, and I have no idea the veracity of this, but I've heard this a million times over my career, that only 10% of the people that can afford private aviation take advantage of it. And I think that changed during COVID. So, a lot of your customers now that only flew first class are now chartering. If they were chartering, they're looking at the different options. So I think COVID's been an accelerator at moving up this chain and being introduced to this chain. But I also think it's a much better experience than 20 or 30 years ago, what the options are.

Keith: Yeah. No, the market has become very sophisticated in the iteration of available options. No question. Yeah, I agree with all of those comments, Don. Great comments. All right. We can move along, unless we have any questions, Bill?

Bill: No question.

Comparing costs of available options (13:36)

Keith: Okay. So, this is a slide, again, that Don, I'd like your substantial input on. This is sort of a matrix. Let me just kind of lay out what everybody's looking at first. This is a matrix of full ownership... Reading along the top, you can see full ownership, managed or shared ownership, fractional ownership, and jet cards. I don't have on-demand charter because that really wasn't an ownership, if you will, option. It's not a packaged option. The cost of capital is not factored into any of these numbers. And what I've covered on the left column there is fixed costs, variable costs, and total fixed and variable costs per hour. And one thing you'll notice is with full ownership, I've assumed that no one would get into full ownership unless they had 300 hours of usage. Now, that's not in fact the case, in my experience. I have many clients that get into full aircraft ownership with more than 100 hours of use, or 150 hours of use. But it's a much higher cost, because now you're spreading the fixed costs over a much lower number of flight hours.

So, to show a comparable average cost per hour, what I've shown there is that to buy a whole aircraft, you'd really need 300 hours. If you were buying half of a plane at 150 hours, you'd have a comparable cost. Except the cost of capital, when you buy the whole aircraft, you're going to bear that whole cost, versus when you own half of a plane, you'd bear half of the cost, so again, a shared ownership would be the cheaper model. And fractional, again, compares somewhat to shared, but it all depends on the number of flight hours that you're going to get involved in. Don, I'll pass this over to you for comments.

Don: Yeah, so, I love this chart. And Keith put together, and we had our consultants kind of walk through it and agree with the math. This is with super-mid-size, maybe a little bit bigger airplane, but a two cabin zone airplane. If you think of aircraft, light jets will start in the five to six person. Large cabin airplanes would be 3 seating zones. This would be for a two seating zone aircraft that... And I do like to say that the experience probably gets better from the right to the left. It certainly gets more where you have more control of it. Maybe more headaches, maybe more things you don't want to deal with, but the fractional ownership, at the annual fixed cost at $600,000, I agree with. There's no one number that makes sense from anybody is where does the lines cross fractional to whole ownership?

First of all, we love fractional ownership. A lot of our customers use it. We, I like the membership programs, but with the membership programs, you're accepting, and absolutely accepting, a lower level of availability and service. And they're great, because they can be... While the costs can be high, the hourly costs, with no other costs, if you're flying 30 hours a year, 50 hours a year, 75 hours a year, it's an absolute no-brainer. So $11,000, have a lot of customers that just, I like to use the number 10. If, figure out how much flying you're gonna do, multiply it by 10,000 and that's about what you're gonna spend, and $11,000 is probably more accurate, so...

I... stop my phone from buzz... On the fractional ownership program, you know, when you roll it all up and get a super-mid-size airplane for $7500 to $8000 an hour, and that includes all your costs of monthly whatever, the cost to fly the airplane, the cost of the crew, I believe it's a much higher level of service. Now you're getting an airplane that looks a lot like, you know, not your own airplane, but they all look the same, the crews are trained at the same level, they're dressed the same. It's just, I think, a better, better experience for, you know, a little more money, because you have to, maybe less per hour, but because you have to commit to so many hours, a little bit more expensive.

The great thing about fractional, though, is you have to match your mission to it, and I'll give you a great example. A PGA Tour pro flies away on Monday to a tournament. He doesn't know if he's gonna make the cut and return home Friday night. He doesn't know if he's gonna stay the weekend. And then he might go home for a night, he might go somewhere else, but he doesn't have to worry about where...scheduling my airplane, where are the crew, where the crew sleeps, where am I gonna put them up? Am I gonna send the airplane back? Can they charter it while I'm sitting around? You don't have any of those worries. It's just very, very simple.

To do out and back, if you fly out and back, you can lower the number of hours, where, like, a typical business trip, you can lower the number of hours, maybe under 200, where whole ownership makes sense. So, it's...there's an interplay of how you use the airplane to what makes the most sense, and that's what we help people with all the time. The managed and shared ownership, we don't do a lot of. I happen to love it. I've always said I've got a partner in every airplane I've owned, which is quite a few, but it's my brother, but it's the same issues that a partner has when they're not their brother or their partner, is who uses it when. So, you've got... I'd love to say you've got the same costs as owning your own airplane, but a lot of them are cut in half. What you pay your pilots is cut in half, your hangar rent is cut in half, your insurance is cut in half.

So, this is a, I think this is an area of growth for our industry. There's a company right now called Partners in Aviation that's kind of making a play to understand it. It's definitely the step between fractional and full ownership, and I don't know that it's been utilized as much as it will be in the future, because I happen to think, you know, having had a partner in airplanes my, what, really, since I started buying in my late 20s, it's a great way to own an airplane. Hard to put together. You know, somebody like Keith can really help you with the keeping, you know, making sure all the problems are solved in the beginning, and not as they come along.

And then full aircraft ownership. You know, the annual fixed costs of $1,200,000. Three hundred hours of usage. The great thing about full ownership, I agree completely with these numbers, is that the cheapest thing you do is go fly another hour. So, we see, you know, especially during COVID, I'm gonna agree wholeheartedly with something Keith said. We have a lot of customers that are buying airplanes that fly 150 hours a year, that didn't used to...that are coming out of fractional, that wanted their own. So they're already sophisticated, savvy travelers, but they're coming out of fractional, and they're buying their own airplane, regardless of the hours they fly.

Most of them, I think, in my experience, once they own an airplane, will fly a little more than they used to, because, again, the cheapest thing you do, you've already covered all the...you've put the capital into the airplane, you're paying your pilots, you're paying the rent on the hangar, your insurance, etc. Putting gas in is the easiest thing you do, because we have a saying, especially with newer airplanes, 10 years and newer, is that the capital can dwarf the operating costs. So, we just, I think, full aircraft ownership is the highest level of experience, and certainly the one you have the most control over. Our customers, if they own one airplane, they tend to use management companies, which we can talk about if someone's interested. But also, if they own two or more, they typically will have their own flight department.

So, agree 100% with these numbers. The great news is, on the full ownership, the more you fly, the less expensive it gets, per hour. Did I do all right on that, Keith?

Keith: Do we have any questions on market pricing from the audience, Bill?

Bill: We do not.

Keith: Okay. All right, well.

Don: Did you cover cover, Keith, what airplanes cost?

Keith: Well, any market pricing questions at all, I would expect we'll get some, and if anybody has a question while we're speaking, we can take it at the end on market pricing, all right?

Don: Great.

Steps to a successful aircraft transaction (22:50)

Keith: Okay. All right, so we'll go to the next slide, then. So, now we're going to move into the steps to a successful aircraft transaction. And so, this is, so you know, this is gonna be an eight-week timeline, from week one, where you'd engage an attorney, tax advisor, you would start your tax analysis to determine if you can maximize your write-offs. I like to believe that engaging the aviation attorney and tax counsel at the outset is typically what most people would do, because the ability to generate tax deductions is going to also drive potentially the budget for what capital you're going to deploy on the purchase.

In week two, you'd complete that tax analysis and ownership structuring, engage an aircraft broker, the broker would then determine mission requirements, makes, models, price points, mission requirements. Don, I'll hand it over to you on other activities that you would commence when engaged.

Don: Yeah, I think the first thing to do is filter the requirements. You know, people come to us usually with a notion of what they want. We tend to measure a lot. We like to help our clients understand the total cost of ownership versus just the price, and, you know, what they're gonna pay their pilots, etc., so we look at... We're measuring the purchase price, whether there's a trade-in or not, all the costs of ownership, the tax benefits, and then the residual value. Residual value is a huge piece of your total ownership cost, so we work a lot on that. Once we're engaged in looking at models, we... And I agree, by the way. I've looked through all, these. Keith and I have talked at length on these slides, and I do think it's an eight-week process. I will tell you in purchasing an airplane, patience is your ally. So, in these very thinly-traded markets, there's oftentimes not an airplane that you want to buy, but there usually is. I will say that right now, the markets are a little thin, so it's taking a little longer to find the right aircraft.

But finding the right aircraft, now, is... People always say, "Well, what's the best deal out there?" Well, it's really hard to know until you... These are such technical machines. You've really gotta get in the weeds on a lot of things before we pick an airplane. But yeah, I agree with all of this.

Keith: Okay. Thank you, Don. So then, really, within the next couple of weeks you'd start identifying aircraft, we'd be negotiating prices, and then with the objective of signing a letter of intent. And as a buyer of an aircraft, you should always take the lead to prepare a draft letter of intent. From my perspective, it's better than allowing a seller to send a letter of intent to a buyer. In week four, you'd start the process of shopping for financing, if you're going to finance, negotiate terms, provide due diligence disclosure and financial information to the lenders, and begin shopping for an external management company, rather than waiting any longer, because bank financing can be a delay, or a long pole in the tent. Management companies generally are not, but this is the right timing.

All right, next slide. All right, in week five, you'd be moving to negotiating the purchase agreement and executing the purchase agreement, which probably would have started right after execution of the letter of intent. And you'd select your desired management company, you'd sign a loan term sheet, and now you can see that's about four weeks prior to closing. Once you get that purchase agreement executed, the broker would locate an inspection facility, and they'd have a commencement date for you to put that plane into an inspection, in week six. The bank would be moving forward, hopefully, with their credit committee approval.

In weeks seven through eight, you'd be completing that pre-buy inspection, and that of course depends on the cabin size, the complexity of the aircraft, the age of the aircraft, how long that inspection takes. Your broker would be negotiating repairs of discrepancies with the seller and the inspection facility, and agreeing on what the seller is going to correct and repair. You'd be negotiating your loan documents and your management company agreements. And in week eight, you'd prepare documentation to implement your ownership structure, conduct your dry run closing calls, and conduct your closing. Now, that's obviously a very rough timetable. Anything can shift in that timetable. I would highlight only that if you're going to finance, the sooner you get your financing going, the better, because that will delay a closing. And if the financing delays a closing, then it's very possible that the buyer will have to come to closing with cash and then finance post closing, which isn't necessarily what the buyer wants to do. So keep that in mind. I'll move on to the next slide unless there's any questions, or Don, do you have any comments?

Don: Yeah, the only thing I'd comment on, Keith, is the earlier you get good at these steps, the better. You know, when Keith says negotiate in the pre-purchase inspection the discrepancies and who's paying for what, he'll do such a good job in the creation of the document that dictates what happens in a pre-purchase inspection, it won't turn into a knife fight. It will turn into a knife fight if your documentation and your contractual agreements aren't really, really buttoned up. And I can't stress enough, lawyers are different than aviation lawyers. Aviation lawyers are very skilled in protecting you, and the gotchas in this process can have huge numbers on them, so I just say that the earlier you get adept at everything in this process, the better.

Keith: Yeah, and that's a good segue, thank you, Don, to the next slide that we're on right now, which is work through the transaction and closing checklists. Not just loan checklists, but closing checklists. The more you have with closing checklists in a dry run prior to closing, the more smoothly the closing will go. Frankly, the closings that we're involved with, you know, it's just sort of a 10-minute, you know, once you get on the phone, everything's already in escrow, everybody already knows the steps to get the closing conducted, and you close and everybody's very happy. We like to close via a conference call, but you can close via irrevocable written instructions, particularly when we represent a buyer, because we are protecting the buyer's funds and the buyer getting clear title, which is why I believe a conference call is highly recommended.

So, funds get released out of escrow, the FAA bill of sale's filed, the registration is filed, an aircraft security agreement is filed if there's a loan, you register your contract with the International Registry in order to perfect your title. The warranty bill of sale is released, and the remaining documents are released out of escrow, and a delivery receipt is issued. So, these are closing mechanics. The next page has a few more of the post-closing mechanics. Next page, please.

Bill: Keith, Keith, I'm gonna interrupt you for just a second with a question that came up, and you can either answer it here or maybe based on the next slide you have. What are your thoughts on evaluating operators, and to get a hangar or not?

Keith: On whether a hanger should be obtained?

Bill: Well, the question is just specific thoughts on evaluating operators...

Keith: Evaluating operators.

Bill: ...and to get a hangar or not?

Keith: When you say operators, I'm sure you're referring to management companies. Is that?

Keith: Yeah, okay. So, I mean, a lot of aircraft owners do refer to management companies as operators. Indeed, they're actually just a service provider, for clarification on that point. They don't operate an aircraft unless they're chartering the plane to the public, at which time they do operate a plane. Otherwise, they just provide support services for the aircraft. Hangar is particularly useful, of course, whether or not you have a management company, to avoid, you know, corrosion and other weather elements, depending on the area of the country you're in, and depending on the capital you've deployed in the asset. So, and I'm a fan of management companies, just in general, particularly for the first-time operator of an aircraft under Part 91, because there is such a steep learning curve in understanding all aspects of an aircraft operation.

Now, I'll just say you can interview pilots. You can interview many pilots who have a high level of confidence in their ability to manage your aircraft without a management company. That is the nature of a pilot. That is the personality of a pilot. That doesn't mean they have the skills, all right? They will always tell you they have the skills. And some do. There's no question. Those pilots that have been in the business for a long time, they've been a chief pilot for many planes, they've worked for management companies, they know how to do it. Others don't. But I'm a firm believer in a management company, and I'd also add that from a cost perspective, a management company is not necessarily costly, because when you work with a management company, they do pass along the industry discounts, along many levels of your operating budget. So, those discounts that they're passing along at many levels on your operating budget can offset their management fee very easily, if not more than their management fee.

Now, there may come a time that an owner-operator would like to have a greater level of control, and if control is your objective, then at some point, you would certainly wean away from a management company. I hope that answered the question.

Don: Yeah, I had the management company selection maybe as important as the aircraft selection. One, I agree with Keith wholeheartedly that I'm a fan of management companies. Owning and operating your own airplane is a lot like starting another business, but it's business that you may not be expert at. So we tend to recommend management companies. I also think in management companies that size matters, that scale is important. When you look at the fuel discounts the big guys get, the discounts on insurance, the ability to get pilots today in an environment where it's very difficult to get pilots. The selection of your management company is just absolutely critical. There's not a lot of regulation, and there is regulation in the operation of the airplane, but there's not a lot of regulation in who can be a management company. So it, I think, behooves you to really look...very, very important part of aircraft ownership is who's gonna be operating the airplane.

Keith: This is an area where both a broker like Guardian jet, or a law firm like mine, can assist you in selection of management companies, negotiating commercial terms, and ultimately negotiating the documentation. We're both, because we do such a high volume of transactions, both of us, we're very familiar with what's standard, what the strengths and weaknesses of the management companies are, each of them, whether they're large or midsize, and what the pricing models ought to be. And you should seek the assistance of any of your advisors in the transaction who can give you that kind of input, because that's market knowledge that's usually valuable.

All right, so, on post-closing issues, once the closing occurs, you conduct title searches to make sure that indeed you have clear title to the plane, you obtain a fly wire if needed. A fly wire, for those who don't know that term, is a temporary certificate of registration. What that allows you to do is to fly the aircraft internationally for, and it's valid for a period of 30 days. If you don't obtain a fly wire, you cannot fly that plane internationally until you receive a fly wire or a permanent registration from the FAA. And that's easy to do. This is administrative. There's nothing challenging about these items. We recommend you get a fuel receipt or other proof of the aircraft location at closing for sales and use tax purposes. Company like Guardian Jet would assist you in transferring all applicable maintenance service programs and contracts, and implementing warranty transfers.

We would assist you in implementing the ownership and operating structure, and that includes, most importantly, cash flow considerations. Cash flow considerations come up with respect to your management company as well. So, you could have the best tax planning and structuring created by us, and it's not implemented correctly, because ultimately, the management company is not familiar with what was recommended, and their billing and invoicing contravenes the planning. And I see that happen all of the time, so there's gotta be some reconciliation between all the moving parts and the players in the transaction, to ensure that everybody knows what's supposed to be implemented.

And then, revisiting the tax planning and ownership structuring periodically is always useful. One important point here, and my last point on this slide, is that you can plan your sales tax with a fly away exemption. For example, when you purchase your plane, and planning your use tax in your state where you intend to hangar your aircraft, and then two years later, after you've acquired title to the plane, that plane can be relocated. A perfect example is someone can decide they want to become a Florida resident, move to Florida, and then relocate their plane to Florida two years after they bought it. What they don't appreciate is that relocating that aircraft to Florida could create a use tax liability in Florida once that tangible property is imported into the state of Florida, by virtue of landing here and being placed in a hangar, or otherwise just having landings here. So, there is a continued tax planning or analysis component with respect to any aircraft purchasing transaction, constantly, after that purchase occurs, and ongoing until the plane is sold.

Bill: Hey, Keith?

Keith: Yes? Yeah.

Bill: Relevant question, which is, how does this eight-week process differ between buying a new aircraft as opposed to a used aircraft?

Keith: Well, you know, I think with a new aircraft, while you have a new aircraft, of course, that could be ready for delivery, and there are those planes that the manufacturers have that are "ready for delivery." So, literally, as soon as you complete the purchase agreement negotiations, and manufacturer's expecting you to close in a very short time table. Maybe the only thing they're gonna be doing is putting some striping on your plane. But in my experience, if a plane is ready for delivery with a manufacturer and they're marketing you a plane that's sort of sitting on the tarmac and ready to go, any modifications you as a buyer do to that aircraft, whether it's painting or equipment or otherwise, they want you to do post closing. So, the long pole in the tent, Bill, in that situation, is going to be financing, if financing is relevant to that purchase. So, and that's always been my experience is if that plane is ready to go when you signed with an OEM, financing's gonna be the long pole in the tent. It's easy to get a management company on board quickly and so...

Now, if you're signing with an OEM on a plane that needs to be built, and you're spec'ing out the interior, you know, now you're quarters if not years away from delivery, so you have plenty of time, obviously, to put everything together in order to have a smooth closing when the plane is ready.

Don: But I think most of the steps are still there, Bill, with the exception of pre-purchase inspection and, you know, if it's selecting a model, that's still, you know, understanding the total ownership cost, that's still very important. Contractual protection is still very important. The management company is still going to be very important. So, most of the steps are still in there when you buy a new airplane.

Keith: Great, thank you.

Bill: Let me ask, a question came up about, and I think this is educational for the listeners, what about CAA membership, and to correlate insurance to require pilot experience, etc. What are some best practices there?

Keith: Don, you wanna take that?

Don: CAA? I'm not sure I know what...

Keith: Is that the fuel buying program and the FBO program?

Don: There's a fuel buying program that we participate in called CAA. Well, listen. Your management company is gonna be... If you think about everywhere you...when you go get on your airplane, the management company is gonna be very much in charge of that experience, both for flying the airplane and what you feel, and also with taking care of the airplane and paying for it and charging you back for it. That's like, you know, I'd say, and I'm a broker that picks out airplanes, and I say picking your management company, for your experience, may be more important than which airplane you get. We're always gonna get you a good airplane. We're gonna buy it at the right price. We're gonna... But it's every time you get in the airplane, having a great experience is very much up to the management company. And those considerations are all, that's a piece of that. Which both Keith and I.

Bill: Let me interject, if you wouldn't mind, because I want to be mindful of our time, and I know you've got another section that we want to cover, which I think is critically important in terms of structuring the taxes and the like. Before moving into that, Don, would you mind just talking about the state of the aviation market today? Pilots and availability?

Don: Sure.

Bill: You know, just so that people know where they stand, certainly, in a historical context, and if you think there's a direction that it's going to be heading in.

Don: Well, I absolutely have some thoughts on it. We file these markets daily, and I'll tell you that the COVID, I got more wrong in the beginning of COVID what I thought would happen than I got right. But if you think that the... It's been a very difficult time to be an OEM since 2008. They'd like to build more airplanes than they are. They're all building kind of the minimum number of airplanes it takes to be profitable. Gulfstream's probably investing more than the other companies, although Dassault's got some new models coming out. Bombardier's got some fantastic Legacy models that they're improving, so I think on the new side, it's still a difficult time. I know that last year, corporate America stopped flying. And when they stopped flying, they stopped buying and selling airplanes. And that fuels a big portion of what goes on at the OEM. So from an OEM buying point of view, this is a very good time. We're in the market, buying new airplanes right now, at very good value.

On the used side, we saw in 2019 inventories increase and the rate of sales slowing down. So, in the end of 2019, the beginning of 2020, we were telling our customers prices are gonna soften. And they did, and we hadn't seen COVID coming. So when COVID came, in the first part of the year, prices got hit pretty hard. We just have seen unprecedented value in the used marketplace. If you have $6, $7 million to spend, it's amazing the different options you have today that you didn't have. Same at $10 or $12 million, $15 to $20 million. So, unprecedented used pricing. That was counterbalanced, or it was balanced by we've never seen a wave of first-time buyers and upgrades that were caused by COVID, that the fourth quarter was incredibly active with people wanting to buy airplanes for tax reasons, but also because they didn't want to get on the airlines again.

So the market became very, very active, and a lot of the airplanes, that increasing inventory dwindled during the fourth quarter. So, still, pricing starting to eke up a little. I wouldn't say it's going up. I think it's firming up, and not dropping right now, because of lack of inventory. But it's a very healthy used market. There's still a ton of value out there in used airplanes, and new airplanes are selling at prices that are very similar to what was three, four years ago, maybe even a little better. So...

Bill: What about pilots, in light of COVID and the obvious impact on the aviation industry? Are we seeing that get better, and is it sustainable?

Pilots (44:11)

Don: There was a real pilot shortage, and COVID's helped that, because the airlines had to... But that's a temporary situation. It really depends on what you think's gonna happen in the airline industry, because they're the, by far, the largest user of professional pilots. So if the airline industry comes back soon, you'll see a pilot shortage again. I think you're probably a couple years away from that. People were, I mean, if you live in an area like... I happen to be out on the West Coast right now, in the Bay Area. You know, getting a pilot to come to work here that doesn't own a home here is very difficult, so the salaries were jumping up and up and up, and COVID's put a temporary halt to that. But, you know, I think we're probably a couple years away from a real pilot shortage again.

Bill: Okay. Great. All right, well, Keith, why don't we turn it back over to you. We want to be mindful of time and make sure that we've got the ability for people to ask some questions at the end, so, but I think, please go to the important things that folks need to know, and obviously they can reach out and follow up with each of you guys for specifics.

Keith: Thanks, Bill. All right, so, I like to refer to code Section 162 as the gatekeeper code section, and the case of Lender Management versus the Commissioner is the leading case in this area with respect to family offices. Get into the next slide. Code Section 162 is, again, the gatekeeper code section. If you cannot pass 162, there's really no discussion with respect to taking operating expense deductions, depreciation deductions, or any deductions in connection with the purchase of an aircraft. Code Section 162 allows a deduction for ordinary, necessary, and reasonable expenses incurred in the conduct of an active trade or business.

All right, so we need, and I didn't add, "that has a profit motive." Obviously an active trader business must have a profit motive. The word "ordinary" refers to expenses that are normally expected in the circumstances. So, an example of that would be if you're generating $1,000,000 in revenue, you wouldn't spend $2,000,000 in transportation costs to generate $1,000,000 in revenues. It wouldn't be ordinary. It's an extreme example, but it's an example. Necessary is an expense that is appropriate and helpful to the business. Reasonable is an expense that is reasonable in amount relation to its purpose.

All right, so, if income is produced by a family office, it needs to be sufficient to justify an aircraft expense. Aircraft have been found as reasonable when it saves substantial time for executives traveling in connection with business, and provided flexibility to travel to places and on dates needed to meet the demands of the business. All right, so, I'll just add a little bit here. The IRS doesn't normally challenge necessary and reasonable, particularly in industries of financial services, investing assets. Those industries have, traditionally, the IRS has assumed that it's reasonable and it's necessary for people to travel on private aircraft. The test that the IRS always challenges is ordinary. They look at whether these expenses are reasonable relative to the magnitude of the business, the revenue being generated, the profitability being generated, and so on. All right, let's go to the next slide.

Lender Management LLC v. Commissioner (48:05)

The facts in the Lender case were that Lender Management created...which was created by two Lender family trusts to operate the Lender Family Office and provide investment management advisory services to family members. It was set up to provide those services to family members and to third party non-family members. The family office was compensated for its services, primarily through profits interest, but it also had management/consulting fees, or investment advisory fees. The family office employed five people. It had a CIO, who the case commented was someone who had the appropriate degrees and who was being paid a market compensation for his services. Investors made disparate investment choices, and the court concluded, and the family took the position, and in this case, the court concluded that it could deduct all expenses under Code Section 162, including those expenses related to an aircraft. Let's go to the next slide.

What are the factors associated with the trade or business in the case of the Lender case? So, in the Lender case, they articulated that the activity was undertaken with the intent to make a profit. So, the Lender family office had a profit motive. They indicated that there was regular activity, and it was considerable to the extent of its scope. And they said that the activity actually commenced. I'm not sure what that actually means, but they actually conducted these activities on a day-to-day basis of investing funds for multigenerational family members and third parties.

All right, let me go to the next slide, which there are some additional factors of what a business-like arrangement looks like. When setting up a family office as a trade or business, some of these factors are very relevant. Engaging legal, accounting, and investment advisory or other services by the family office, to supplement, particularly with the investment advisory, to supplement those services that the family office itself has internally. Having non-family full-time employees, payment of compensation to family members who are working at the family office, because oftentimes, we see family members not compensated. Holding regular meetings with clients, having formal contractual relationships, so, you have a contract showing your fee schedule and other things. Having physical office space. Having detailed financial reporting.

So, that's it on the Lender family office case. What I want to add is this is the only case we have. So when I get a call from a client who says, "We're setting up a family office, we want to have a plane in the family office, we want to make sure we can deduct the aircraft," the Lender case is the only case we can point to as any evidence of what the IRS has acquiesced to at this point, or would acquiesce to at this point, and what the courts have said is a trade or business with a profit motive, where an aircraft would be a reasonable expense.

So, when you deviate from these facts, it makes it sort of difficult for anybody to opine or give you a comfort level as to whether you have enough attributes of a family office with a profit motive. I'd also add that, you know, there are varied planes. Don has already said, you could have a plane in the $6 to $7 million range, and you can have lots of options in today's marketplace. You could also go to a manufacturer and buy a $70 million plane. So, if you buy a $70 million plane, and you have an operating budget and a capital expenditure associated with that plane, versus a $6 million plane, those are very different expenditures. And so, the type of plane we're talking about would also be germane to the issue as to whether or not the aircraft is reasonable, the costs you're incurring are reasonable relative to the revenue, and profitability associated with the family office.

Now, there's no bright-line test. I wanna underscore that. There's no objective analysis that you can do. This is a subjective analysis, which is facts and circumstances, and that's what it always is. And then, the last sort of component of the equation is the aggressiveness of you as a client, and how you handle your tax reporting, from an aggressive perspective or a conservative perspective. So, all of those are in the melting pot of whether or not your family office could acquire a plane and take deductions, and whether you're going to file a tax trade and whether you would survive scrutiny if you got audited. And that was a mouthful, since I only have a few minutes. I have a few more code sections that I wanted to cover on my very last slide, so why don't we go to that?

Additional Critical Tax Issues (53:10)

All right. These are the other, what I would call highly relevant code sections. Code Section 280F is the code section that deals with the eligibility for getting accelerated, that's modified accelerated cost recovery, MACRS, accelerated depreciation, and it gives you the rules associated with getting MACRS depreciation, and what's important to know is you need to be eligible for MACRS depreciation for every year of your depreciation schedule in order to take bonus depreciation, which, as many of you know, is the ability to take a 100% write off on your purchase price up to a 100% write-off on your purchase price in the tax year that you acquire and place in service the aircraft.

So you have to be eligible for MACRS for every single year. MACRS has basically what's known as a 50% qualified business use test. I'm not gonna get into this any more. It's a complicated code section. I could spend 30 minutes discussing it, but if anybody has any questions, they have my email address, and they certainly could email me a brief question if they're not a client, and I'd be happy to respond.

The next one is Code Section 469. 469 is an important code section because this code section deals with whether your tax write-off is going to be classified as passive or nonpassive. So what's important to know about Code Section 469 is you could acquire this plane, you could be eligible for MACRS, you could be planning to get your bonus write-off, and then, because of how you've structured your use and operation of the aircraft, those write-offs, that 100% write-off could be classified as passive. Now, that's a passive tax loss on your tax return. If you don't have passive income on your tax return, then that write-off will generate a deduction on your current tax return. So that's a big code section.

274 is the code section that deals with your disallowance of deductions associated with entertainment and commuting use of an aircraft. Again, you could plan to get bonus depreciation, be eligible for MACRS, you can go past code section 469, not have a passive problem, and then your usage profile in the year you buy the plane could be heavily entertainment and commuting, and you'd lose most of your write-off, so this is a big code section.

The last one to mention here is Code Section 465. This is a basis and at risk, Code Section 1367. If you're a corporation, 705. If you're a partnership, basis in that risk limitation rules typically only are a gotcha in the event you're borrowing money in connection with the purchase of an aircraft on a fully non-recourse basis. So, the takeaway on Code Section 469 is very straightforward. It's non-recourse financing will create an issue limiting your ability to take tax write-off. So, when you negotiate that term sheet with a bank, if you think non-recourse financing is what you want, you need to reconsider if you're also looking to take write-offs and you have basis... Because you'll have at risk limitations, and you might also have basis limitations. Again, I'll just end by saying, you know, I know you wanted me to cover tax, but because of all the other things we covered, these are important code sections. I could spend another couple of hours talking about them, but as long as you know about them at the level I've given you sort of the important components to be aware of, you'll know that you have an issue if you see one, and then have it looked at in more detail.

Bill: That's great, Keith. And look, in the interest of time, and candidly, so many of these questions require a fairly lengthy, complex answer, that instead of going over questions, I'd like to wrap it up with just some overarching comments, and then thank you guys, and then...as well as remind everybody that part of the purpose of this is so that you have the contact information for both Keith and Don, and you can follow up with them directly. You know, private aviation is for family offices, increasingly, and I think will continue to be, so an important part of the area of responsibility for the family office professionals. There is a steep learning curve. It requires true expertise that goes beyond traditional legal advice, goes beyond, the aircraft management companies and the like. And there are lots of "It depends" answers about whether or not you can avoid sales tax, and whether or not you can deduct the plane, and how you can use those deductions, and how you keep track of it. And so, it's very important to spend a fair amount of time not just learning about the process that Keith outlined here, but also understanding the market that Don summarized, and then working with appropriate counsel in working through what it is you want to achieve.

So, with that, and be mindful again of time, I want to be particularly appreciative of the time that Don and Keith gave, as well as your attendance. We obviously covered a lot here. There's a lot more to cover. I'd also like to thank all of you who joined us today, and certainly if you would like to get in touch with our speakers, you can send me an email at familyoffice@bostonprivate.com, and our team will make sure to get you directly to them, or to the contact information that certainly Keith provided in his presentation, and Don, I'm not sure made available directly in this webinar, but we can make sure that we can get you to him, to the extent that you have a question for him as well. With that, Don, Keith, thank you guys very much, and everybody have a great day.

Keith: Thank you.

Don: Thanks.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of SVB Private or other members of Silicon Valley Bank and SVB Financial Group. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein