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(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!)

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(Listen Here 8:34 min)

Today’s podcast is entitled “Mergers Acquisitions and 1031 Exchanges.” Many people conducting mergers, acquisitions and the purchase and sale of businesses have so many things in the air to keep track of, that they often lose sight of the important tax efficiencies under section 1031.

The Most Tax Efficient Way to Sell Business Property

Remember, if we convert a transaction from a sale to an exchange, under section 1031, we can defer all the taxes on the disposition of like kind property indefinitely. The fundamental requirements of section 1031are as follows:  The relinquished property that is given up must have been held for investment or for use in a trade or business,  it must be exchanged for like-kind property that must also be held for an investment or for use in a trade or business. By characterizing the transaction as an exchange, as opposed to a sale, we get to defer or have the gain go unrecognized indefinitely.

1031 Exchange Rules

Now, let’s talk about how we can mold 1031 into a sale of a business:

Imagine we are selling a restaurant chain. Each of those restaurants sits on real estate and have some buildings or improvements that are considered real estate. Real estate is very easy to implement a 1031 exchange on. As a matter of fact, when most people think of 1031 exchanges, they often think of commercial real estate because commercial real estate is frequently exchanged as opposed to sold.

In addition to the real estate, we may also have items of personal property or chattel. These are movable items such as stoves, refrigerators and other accoutrement that would be used in the restaurant business. Guess what?! 1031 applies to personal property as well as real estate! The thing to remember is, in the realm of personal property, the like-kind requirements are far more stringent. In real estate, a condo can be considered like-kind with raw land, an office / industrial property can be considered like kind with residential. Just about any real estate in the United States that is held for “investment” or “used in a trade or business”, will be considered like-kind with other United States real estate that is also held for an investment or used in a trade or business. Now, in personal property, the like kind requirements are a bit more exacting. In personal property (Personalty or chattel) exchanges, a “heavy duty truck” could be exchanged for another “heavy duty truck”, a combine used in agricultural purposes could be exchanged for other agricultural equipment. The like kind requirements are just more precise and exact.

Some Property will Not Qualify for 1031 Exchanges or Deferral of Taxes

There is another category in a business that cannot be exchanged under Section 1031. This category deals with the “going concern” or “good will” of a business. Remember that the good will of one business will never be considered like-kind to another business’s good will. This comes out of the treasury regulations [1.1031(a)-2(c)], so unfortunately part of the sale of the business will likely be subject to some tax. It’s a good idea to set out in your asset purchase and sale agreement, some value for good will. Attribute your value to it, pay your taxes on it; but as to the other components, the real estate and personal property, you want to layer in a 1031 exchange to get the most tax efficient disposition of the business as a whole.

Hotels and Motels Make a Good Exchange of Businesses

Let’s talk about a category of business that is ripe for 1031 exchanges: the hotel and motel industry. Often, the operators of hotels and motels have about a 5-7 year hold time before they want to exchange into something different, another bigger and better hotel. 1031 exchanges can be layered into a hotel transaction very easily and hotels make a great example of both personal property (the bed, furnishings, etc.) and the real estate (the dirt the hotel sits on, plus the improvements / the building that sit on the real estate). Remember, 1031 exists to encourage people to continue to invest into another like kind property. In my experience, hotel operators like to buy more of what they know and understand; they want to expand into bigger better hotels to compound and build their hotel portfolios over time.

What Else Makes a Good 1031 Exchange?

Let’s talk about some other business where we could layer in 1031 exchanges.

1031 Work Very Well for TV and Radio Stations

The sale of television or radio broadcast stations often times have a FCC license, which can be exchanged for another FCC license in a bigger better market. Also included in the sale of a TV or radio station would be some other items, the transmitter tower, and personal property that goes along with the radio station, as well as some real estate, the buildings and improvements that the business operates in.

1031 Apply to the Sale Sports Franchises

The sale of a major sports franchise is another good example. In a sports franchise, you have the major league sports contracts (that’s personalty) as well as other improvements and buildings that the sports franchise operates out of. If you move out of a minor league sports franchise, into a bigger league sports franchise, we could conduct that as an exchange. We could dispose of the old sports franchise and with both a real property and a personal property exchange, we could exchange into a bigger better (sports) market.

Focus on the Tax Incentives in Brokering a Sale of a Business

In summary, let’s remember when we are structuring the sale of a business, to always contemplate how we can do this in the most tax efficient manner. 1031 is a valuable tool for folks selling their business. Remember the like-kind requirements of real estate are very broad, so if I’m getting out of the grocery business and want to put my investments on auto-pilot, I could exchange into a management free (real estate) investment and still preserve my capital by deferring the recognition of all of the capital gains tax from my old grocery store buildings and real estate.

Mind the Personalty …Chattel and Movable Items!

Another important 1031 tip, is 1031 is broader than just real estate and we can conduct exchanges of personalty. That means personal property of things, such as: artwork, coin collections, breeding stock, racing horses, gold coins, business equipment, agriculture equipment, aircraft, collector cars that are held for investment; the list of personal property you can conduct exchanges on is immense!

Eliot Spitzer, the disgraced former New York governor, bought a prominent office building near the White House, part of his attempt to re-emerge in public life.