Note: With the passage of the Tax Cuts & Jobs Act of 2017, 1031 exchanges of personal property are no longer valid.
Many people are unaware that Section 1031 of the Internal Revenue Code applies to aircraft as well as other types of personal property. In order to qualify, both your old aircraft (relinquished property) and your new aircraft (replacement property) must both be used for investment or use in a trade or business and must be like-kind. Aircraft that are used for personal or recreational-purposes do not qualify for 1031 treatment.
Aircraft Exchange Like-Kind Requirement
The first thing you need to know when it comes to exchanging aircraft is that aircraft are personal property (they are chattel) as opposed to real estate. Essentially, this means that determining like-kind status is more stringent. 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.
Your exchange has to be of like-kind (or in this case like-class) property. Generally, all US aircraft are considered like-kind to any other US aircraft because they are listed in the same General-Asset-Class. All of the following fall under the aircraft General-Asset-Class 00.21:
- Airplanes, including airframes and engines
- Helicopters, including airframes and engines
Commercial aircraft or aircraft used in air-charter service (passenger or freight) are not within the aircraft General-Asset-Class 00.21.
Timelines & Value Requirements
An aircraft exchange must abide by the standard 180 day / 45 day 1031 exchange requirements.
Additionally, in order to defer all of the gain, your new replacement aircraft should be equal or greater in value than your old relinquished aircraft, and all of your equity (or proceeds) from the sale of your old relinquished-aircraft should be reinvested into your new replacement aircraft. Depending on where the aircraft is located, there are a number of special considerations involving both sales and use-tax in aircraft transactions.
Sales & Use Tax
Sales taxes are usually due to the local taxing authority at the time of transfer of the aircraft, and are generally required to be collected by the seller of the aircraft. Use taxes are generally payable by the purchaser of an aircraft, if the seller does not collect and remit sales tax.
Is an Aircraft 1031 Exchange Right for you?
Given all this information, when is it appropriate for a taxpayer who owns an airplane to do a 1031 exchange?
First, you need to satisfy the proper holding purpose. The aircraft must have been held for investment or use in one’s trade or business as opposed to a personal recreational use. 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.
Next, you have to determine if it’s appropriate from a tax point of view to structure the exchange to defer the taxes. 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.
Minnesota Aircraft Exchange Services
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.
If you own an aircraft in Minnesota and are considering deferring taxes in a 1031 exchange, contact us today to discuss your options - 612.643.1031.