| Some Plane Overhauls Can Be
A commercial airline,
in order to conform to strict government safety
standards, adopted a maintenance policy that
required each of its airplanes to undergo a
complete overhaul every eight years. Typically,
each plane was out of commission for approximately
45 days while a $2 million face-lift was
In the past the IRS relied
on TC Memo 2000-32, which held that Ingrain
Industries heavy-duty maintenance of its towboat
engines had to be capitalized. Also, a 1996
private letter ruling (no. 9618004) held that FAA
rules mandating periodic overhauls were clear
evidence that capitalization was required.
However, in revenue ruling 2001-4, the IRS
softened its stand in this area and took a less
restrictive approach to deducting periodic,
heavy-duty maintenance and overhaul expenses.
According to the IRS, incidental repairs that do
not materially add to the value of an airplane or
appreciably prolong its useful life but merely
keep it in safe operating condition can now be
expensed immediately. Examples of such repairs
include inspecting, testing, servicing, cleaning
and repainting the aircraft.
that stop the deterioration and appreciably
prolong the useful life of the plane, however,
must be capitalized. This includes removing,
replacing or upgrading major components of the
plane, such as all of the belly-skin panels,
wiring in the wings, avionics and cockpit
equipment, fire detection and ground-proximity
warning systems, as well as the fuel tanks,
windows, seats, carpeting and galley.
Sale of Property Occurred When
A taxpayer formed a
proprietorship in order to generate tax savings.
The business sold residential real estate through
contracts for property deeds to poor families with
little or no credit history. Once a contract was
signed, the buyers obtained possession; were
completely responsible for the propertys
maintenance, taxes and insurance; and were obliged
to make monthly payments of principal and interest
toward the purchase price. Upon the last payment,
20 or 25 years later, the buyers received a
warranty deed. If the buyers defaulted, the
taxpayer would retain all payments as liquidated
damages. The buyers were also free to alter the
property in any way.
reported the transactions on schedule C. She
recorded the annual interest payments as income,
and she depreciated the real estate. The principal
payments were treated as mere deposits against the
purchase price of the homes and were recorded as a
liability. It wasnt until a contract was fully
paid that the taxpayer recognized the actual sale
of the homes.
The IRS said that the
taxpayers method of accounting was improper and
did not clearly reflect income. Instead, the sale
of the homes should have been recognized at the
time the contracts were executed, not when they
were paid off.
The taxpayer, however,
argued that the contracts were merely voidable,
executory agreements until final payment was
received and that a completed sale did not occur
until the title was transferred upon receipt of
the final payment.
Following state law,
the Tax Court found that the transfer of legal
title is not a prerequisite for a completed sale.
According to the court, the contracts for deed
were sufficient to confer the benefits and burdens
of ownership on the buyers. In essence, the buyers
were given equitable ownership and the seller was
left with a security interest in the property. As
a result, the court ruled the taxpayer must report
the gain on the sale of the homes in the year that
the contracts were executed (J ames W. and
Laura L. Keith v. Commissioner,
115 TC no. 42 (12-29-00)).
Reducing IRA Payment Not a Modification
A taxpayer under age 59
12 can escape the 10% penalty on early
withdrawals from an IRA (or other qualified plans)
by taking a series of substantially equal periodic
payments based on his or her life expectancy.
However, the penalty for early withdrawal will
apply if such payments are substantially modified
(other than by death or disability) before the
taxpayer reaches age 59 12 , or before the end of
5 years beginning with the date of the first
payment and ending after reaching age 59 12 .
In letter ruling 200050046, a taxpayer,
under age 59 12 , took $300,000 a year from his
IRA for three years. In the fourth year, he
divorced his wife. As part of the property
settlement, she received $100,000 a year of his
IRA tax-free under IRC section 408(d)(6). The
husband reduced the payments he received to
$200,000 a year. According to the IRS, this was
not a modification. The husband could
proportionately reduce his equal periodic payment
without triggering the 10% early distribution
penalty under IRC section 72(t)(1).
IRS also stated that in any year after the husband
reached age 59 12 , he would be free to change the
amount of his distribution without having to pay
the 10% penalty if he previously had received five
payments (even if some were at post-divorce
Last year, in another
case (letter ruling 200027060), the IRS said an
ex-wife was not required to conform to her former
husbands distribution plan. She was free to
establish her own IRA and receive distributions as
allowed under IRC section 72(t)(2)(A) without
Michael Lynch, Esq.,
professor of tax accounting at
College, Smithfield, Rhode Island.