Flight 1031 – Aircraft Exchanges

(Listen Here 5:00 min)

In this 1031 podcast, we’re going to be discussing how to do a 1031 exchange of aircraft or airplanes. First thing you need to know is aircraft are personal property (they are chattel) as opposed to real estate, which means it is in a more stringent “like-kind arena” for determining whether or not the property received is going to be considered like-kind. The IRS has set out thirteen general asset classes (for depreciable tangible personal property). The fourth asset class is for airplanes (except those used in commercial or contract carrying of passengers or freight) and all helicopters. A general asset class that is 00.21

1031 Transfer Within the Same Asset Class

This asset class (00.21) is generally applicable to most airplanes and helicopters, of course unless they are used for commercial or contract carrying of passengers or freight. So let’s determine when a 1031 exchange would be appropriate for a taxpayer that owns an airplane:

You Must Have an Intention to hold the
Exchange Property for a Qualified Purpose

First, we need to satisfy the proper holding purpose. The aircraft must have been used (held) for “investment” or “use in one’s trade or business” as opposed to a personal recreational use.  (Note: If you hold your aircraft as a hobby for fun and enjoyment, then you may not qualify for a 1031 exchange at this time because you have not used it for a qualifying purpose. You still may be able to rehabilitate your aircraft into a business property.)

What is Your1031 Exchange Basis?

Next, we have to determine if it’s appropriate from a tax (accounting) point of view to structure the exchange to defer the taxes. We need to really sharpen our pencils to figure out how much gain is on the sale of this airplane if we just took the cash and sold it outright. Let’s say the aircraft has been depreciated on a 5 year, double-declining balance schedule. (That means that over the course of 5-6 years you will have a zero basis.) If your basis is low and your sales price is high, that probably means that a 1031 exchange is in the cards. You are going to want to defer the gain, and roll the taxes (and the corresponding tax liability) into another aircraft that will be considered like kind. That way you will continue to use your money and keep your capital working in your business as opposed to unnecessarily paying taxes sooner than you need to. Your basis in the replacement aircraft is the fair market value of the (new) aircraft, less the amount of gain you deferred on the sale of the old aircraft. Typically, you see taxpayers buying more expensive new aircraft so they can continue to take future depreciation deductions on the new basis they acquire on the new bigger better aircraft.

Let’s summarize the big points:

Yes - Personal Property Can Be Exchanged Under Section 1031

We can do 1031 exchanges on personal property; that includes aircraft predominately used within the United States and exchanged for other aircraft that will also be predominately used within the United States. (Note: You can also conduct an exchange of foreign aircraft for other like-kind foreign aircraft…you just can not mix the two categories)

Faster Depreciation of Personal Property
Means Larger Capital Gains…or Savings

How much gain or tax liability does one save by structuring the transaction as a 1031 exchange? Because we are able to depreciate personal property far more rapidly than real estate, it means we are more motivated to structure the transaction as a 1031, rather than taking the cash and calling it a (taxable) sale.

Engage Your Qualified Intermediary…Before You Sell Your Airplane

The last thing to remember is to involve your Qualified Intermediary EARLY before you dispose of your old aircraft. The Qualified Intermediary will take the proceeds from the sale of your old aircraft, place them in escrow, and apply them for the purchase of your new aircraft. It’s essential that you do not touch the proceeds! If you receive the proceeds, it will be considered a sale by the IRS and the tax would be recognized. Involve your Qualified Intermediary well before you dispose of the old aircraft to ensure you are insulated from receiving proceeds. (Think of the proceeds as being radioactive!)

About the Author:

Jeff Peterson (AKA: "Professor 1031") is a Qualified Intermediary and Serves as an Adjunct-Professor for the William Mitchell College of Law (Where He Teaches About Federal Income Tax). Jeff Works With People From All Over the USA to Save Money on Federal Capital Gains Taxes.

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