April 28, 2015 - If a business owns a full or fractional interest in an aircraft, it will eventually need to be replaced. Unfortunately, a tax liability is often associated with these transactions.
The fact is the gain need not be recognized if the transactions are structured as tax deferred exchanges and the tax dollars that would otherwise be paid in a direct sale can then be utilized to purchase new aircraft. Compare a sale versus an exchange.
- A business purchases an aircraft for corporate use for $9,200,000
- After five years the aircraft is sold for $2,400,000
- Since the aircraft has been depreciated over its useful life its tax basis is approximately zero
- When the aircraft is sold the entire $2,400,000 sale price is treated as a gain
- Assume federal tax rate is 35% on depreciation recapture
- Assume the business’ state tax rate is 6% (Federal deduction for state taxes is not included).
- Result: The business that exchanges its aircraft, instead of purchasing with after-tax dollars, will have an additional $984,000 to invest in the purchase of a new aircraft.
To qualify as “like-kind” property for a §1031 exchange of tangible personal property the exchanger’s relinquished and replacement properties must be property that has been and will be held for productive use in the exchanger’s trade or business or for investment and must be in the same general asset class or product class.
As a general rule of thumb, to avoid paying any taxes in an exchange, the business aircraft owner should always attempt to:
- Purchase equal or greater in net sales price (value)
- Reinvest all of the net equity in replacement aircraft
- Obtain equal or greater debt on replacement aircraft
Exception: A reduction in debt can be offset with additional cash from exchanger, but increasing debt
cannot offset a reduction in exchange equity.