Happy Holidays From HR1

If your job has anything to do with aircraft transactions, the new tax bill will ensure you never see your family again during the holidays. When your partially orphaned children wonder why they were alone with the dog on Christmas morning, their therapist can help explain that mom and dad were volunteering (for compensation) to bring gifts (big tax deductions) to the needy (large profitable corporations and the strato-wealthy). Hopefully, the kiddos will understand these gifts had to be delivered by the New Year or else Scrooge McGovernment would have taken them away forever (one year). Please tell the therapist to avoid a 1031 discussion – the metaphors get too weird.

Tax Bill: Key Points and Some Thoughts

  • Lower Corporate Tax Rate
  • 100% Expensing on New and Used Equipment
  • Repeal of the 1031 Like-Kind Exchange

Most people we’ve talked to feel the central aspects of the new tax bill will be a net positive for the industry. We’ve even heard it speculated that 100% expensing will light the pre-owned markets on fire. Perhaps. But, consider the rest of the landscape – historically low asset values, free-ish money and cheap fuel – i.e. the holy trinity of bizjet market adrenaline. Even with these perfectly advantageous conditions, our markets have only managed to find a friction point in the past year after a decade of atrophy – p.s. the Dow is above 26,000.

Therefore, we doubt the new tax bill will stimulate aggregate demand beyond any macro-economic byproduct of lower corporate taxes. The deck is already stacked. However, that’s not to say the new tax bill doesn’t have consequences:

Tax This … (less)

Paradoxically, the after-tax cost of owning a business jet just went up by 14% for many organizations as a result of the lower corporate tax rate (state taxes aside). Like it or not, airplanes are non-core depreciating assets that contribute indirectly to the top line but directly to the bottom line. Here’s another way to look at it: previously the government paid for 35% of the jet. Now they pay for 21% and you have to make up the difference out of your shareholder’s profits.

I Want it All and I Want it Now!

Even if 100% expensing doesn’t necessarily ignite demand, it will absolutely impact timing. The purchase of a $20M used aircraft now returns $4.2M to the bottom line in the first year, as opposed to just $1.4M before. That’s almost like real money and exponentially magnifies the stakes of closing before baby New Year arrives. Organizations contemplating the purchase of a jet will have a huge incentive to pull their decisions forward. We’ve always dealt with the pressure of year-end transactions, but it will now feel like a mania.

The unintended consequence may be that even more badly advised and poorly thought out airplane decisions will be made in a blind rush at year’s end. Depreciation-ism is on par with other addictive and sometimes illegal behaviors. Think indiscriminate buying; “pre-buys” in the hangar; test flights on the way to closing; handwritten contracts; squawk lists on sticky notes; IOU’s; hold backs; delivery receipts with smudgy notes on them; missing paperwork; months of trying to locate the loose equipment that nobody had time to think about; and, predictably a massive headache the next morning as you wake up beside your new flying money pit … that you didn’t even realize you were buying just three weeks earlier when some bright advisor said “you know …”

Rational actors will take this into account and not leave their aircraft selling and buying until the 4th quarter. Since most actors will choose to be irrational, this counterintuitive and boring “plan ahead” technique may yield superior market opportunities.

The 1031 Blues

Killing the 1031 like-kind exchange is a big deal if you are in the like-kind exchange business, but 100% expensing takes the sting away for most companies. If the purchase and sale occur in the same calendar year, the result will be the same but better. The buyer will effectively receive a 100% deduction on the net basis of the new plane. This will further incentivize year-end transactions. However, it’s not such a big deal if the sale slips into the following year. We will still get the golden depreciation ticket up front and effectively delay payment of the gain until next year. When we don’t even know if we will still work here.

OEM’s Need a New Schtick

Finally, new aircraft just became more expensive relative to used aircraft since 100% bonus-accelerated-depreciation-expensing (or whatever it’s called) now applies to all airplanes equally. How much more expensive? The old 50% bonus allowance for new aircraft may have been worth four or five hundred thousand on a $20M airplane over and above 5-Year MACRS – and that was at the higher corporate tax rate. So think two or three percent.

OEM sales people shouldn’t lose sleep over it. Their struggles are due to two factors: demand and pre-owned pricing. In other words, demand. Five-year old used planes presently sell for around 65% – 70% of new. That’s a crushing value proposition considering the reliability and longevity of business jets. Until global demand re-establishes historical depreciation curves, the OEM’s will continue to fight an uphill battle. Losing the bonus depreciation advantage is a rounding error. And, if 100% expensing does light the pre-owned markets on fire, the OEM’s will be the ultimate beneficiary.

Last Suggestion 

Let’s move the Super Bowl to President’s Day weekend and exchange gifts then. Nobody needs to get anything done in February. In fact, take the whole week.