Like-Kind Exchanges: Understanding All The Applications

When deciding to sell an aircraft and replace it with an alternate aircraft, many owners already know to consider the possibility of a like-kind exchange under Section 1031 of the Internal Revenue Code. In instances in which aircraft have been held for either productive use in trade or business, or for investment, 1031 like-kind exchanges are common transactions. However, aircraft owners often are unaware of all of the situations in which the 1031 rules can be utilized.

Application of the like-kind exchange procedures should also be considered in many other aircraft sale situations including, but not limited to, the following: helicopter for fixed wing airplane or vice versa, fractional share for whole aircraft, whole aircraft for multiple fractional shares, and fractional share in one fractional program for a fractional share in another program. Jeff Towers of TVPX 1031 Exchange Co. says, “People are often pleasantly surprised to learn that 1031 exchanges may be structured in a variety of ways and in many cases can be coordinated with other tax planning opportunities, such as maximizing the benefits of bonus depreciation, sales tax exemptions and trade-in credits.”

In order to fully defer the gain, the new property (replacement property) value must be equal to or more than the property being sold (relinquished property). Transactions that do not qualify include the sale of an aircraft for which a replacement property is not identified in 45 days and/or is not acquired within 180 days.

Typically, when a company sells an aircraft, the amount of the sale price that is greater than the adjusted tax basis results in a gain or loss, which is taxable unless there is an exception. One of the most common exceptions available when selling an aircraft is an exchange of the property for another property of like-kind. Internal Revenue Service regulations provide that the property is of like-kind if it is exchanged for property that is either like-kind or like-class. In some cases an aircraft used in commercial transportation may be exchanged for an aircraft used in non-commercial operations. A fractional interest can be exchanged for a fractional interest in the same fractional program, a different fractional program or for a whole aircraft. Often an airplane can be exchanged for a helicopter.

Once it is determined that the two properties are of like-kind or like-class, the structure of the transaction can take on various forms, but most typically a forward like-kind exchange or a reverse like-kind exchange. In both instances, the sale of the relinquished property and the acquisition of the replacement property need to take place within 180 days of each other.

In a standard forward exchange, the aircraft currently owned is sold. The proceeds of the sale are placed with a like-kind intermediary and remain there until the replacement aircraft is purchased. Then the proceeds are used as part of the purchase price of the replacement aircraft. The replacement aircraft must be identified no more than 45 days after the original aircraft is sold.

In a reverse like-kind exchange, the replacement aircraft is purchased before the original aircraft is sold. In such a case, the qualified intermediary (“QI”) or its affiliate will also act as an exchange accommodation title holder (“EAT”). The EAT will hold title to either the replacement property or the original property until the original property is sold. It is important to note that the original aircraft must be sold within 180 days. Sellers sometimes face accepting a lower offer on the aircraft in order to sell the aircraft within the like-kind exchange window. The clock starts on the day the replacement aircraft is acquired. In a forward exchange, the aircraft owner definitely has more control over the timeline, since the sale occurs first.

It is important to note that an exchange in its purest form is a two-party swap that occurs on the same day. But deferred exchanges are far more common. In the case of a deferred exchange, a QI is mandatory. The QI will hold the proceeds from the sale and then remit the proceeds to be used towards the purchase of the replacement aircraft. The funds can’t be co-mingled and they cannot be held by the buyer of the original aircraft, even if the buyer of the original aircraft is also the seller of the replacement aircraft (for example, if the trade of a fractional interest for another fractional interest is not occurring simultaneously, then a QI must hold the sale proceeds until they are applied by the QI to the purchase price of the replacement property).

Remember, if you own a fractional interest, helicopter, aircraft for Part 135 use only, aircraft for mixed use or pure Part 91 aircraft, your asset can be exchanged for another asset of like-kind or like-class. Be aware that the like-kind exchange offers far broader applications than you might have previously considered.

 Amanda Applegate is Senior Transactional Counsel at Aerlex Law Group in Santa Monica, CA.