IRS provides guidance on like-kind exchanges of aircraft

Memorandum clarifies whether aircraft are "held for productive use in a trade or business" when held by a special-purpose entity.
By Raymond C. Speciale, Esq., CPA, and Ronald D. Golden, Esq.

In a Chief Counsel Advice (CCA) memorandum, the IRS Office of Chief Counsel concluded that aircraft owned by a partnership that does not generate an economic profit can be considered, within the meaning of Sec. 1031, to be held for productive use in a trade or business when used for a related entity that serves a business purpose.

In the aviation industry, it is common to place aircraft in a special-purpose entity for legal, liability, and other business purposes. The aircraft then is often "dry-leased" (leased without a crew or other services) to a related operating entity or entities. The special-purpose entity will often operate without economic profit because leasing fees usually only cover operating expenses. The CCA examined whether, without economic profit for the special-purpose entity, the aircraft could be deemed "held for productive use in a trade or business" for purposes of a like-kind exchange under Sec. 1031.

The CCA focuses on a partnership that owned multiple aircraft (Partnership P). P dry-leased both relinquished and replacement aircraft to another partnership (O) that owned P and other entities. Aircraft were the only operating assets of P. Both P and O were owned by the same two partners (through wholly owned entities). The partners used the aircraft for personal and business purposes. When the aircraft were used for personal purposes, the individual partners appropriately recognized fringe-benefit income.

The lease payments for the relinquished aircraft were roughly equal to fair market rental value. On the other hand, lease payments for the replacement aircraft were below market rates. In both instances, the amount of lease payments collected covered carrying costs for the aircraft. However, the CCA notes that leasing rates "were not designed to generate meaningful economic profit."

The IRS field office handling the case determined that P did not hold either aircraft for productive use in a trade or business. Without any definition of the term "held for productive use in a trade or business" in the Code or regulations, the field office turned to Sec. 183 standards. The field office took the position that a determination of profit motive would need to be made on an entity-by-entity basis. Therefore, the profit motive of O could not be attributed to P, and it was concluded that the aircraft were not held for productive use in a trade or business.

However, the CCA states that there "is no authority suggesting that the standards of [Sec.] 183 should be used to evaluate whether property is held for productive use for purposes of [Sec.] 1031." Instead, the CCA appears to take a broader view, taking into account the interconnectedness of the entities involved in the larger business enterprise.

The CCA acknowledges that "O operates a legitimate business enterprise and requires private aircraft to be available to its senior executives." It recognizes that for "business and legal reasons, O has structured its affairs so that the aircraft are owned through P and leased to O for an amount not intended to generate a profit for P." On those facts, the CCA concludes that the aircraft were held for productive use in a trade or business.

The CCA suggests, however, that if P had been a sham entity, the analysis and conclusion reached might be different. It also notes that while P's below-market rent did not affect the eligibility of the transaction for Sec. 1031 treatment, it might cause the disallowance of tax benefits claimed by P, O, and their individual owners.

  • CCA 201601011

—By Raymond C. Speciale, Esq., CPA, associate professor of accounting and law, Mount St. Mary's University, Emmitsburg, Md., and Ronald D. Golden, Esq., deputy general counsel to the Aircraft Owners and Pilots Association.


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