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UPGRADING YOUR AIRCRAFT?
CONSIDER A REVERSE LIKE-KIND EXCHANGE
Maximizing the Benefit of a Buyer’s Market
Aircraft values have fallen at an unprecedented rate since the financial turmoil in the 4th quarter of 2008. Although no one can accurately predict the bottom of either the aircraft market or the stock market, a recent surge in activity appears to support a theory that aircraft values are bottoming out. While selections are plentiful, and pricing is favorable, this may prove to be an opportune time to upgrade your aircraft.
The Benefits of a Tax-Free Exchange
Aircraft used in a trade or business are generally depreciated over a five year life using an accelerated schedule. When the aircraft is sold, the proceeds in excess of the depreciated basis are generally subject to depreciation recapture. As with other equipment, if the taxpayer chooses to replace the equipment with like-kind property depreciation, recapture can be avoided in a like-kind exchange.
A direct, simultaneous dealer trade-in will normally qualify as a like-kind exchange. However, the tax law also extends this treatment to non-simultaneous exchanges when certain conditions are met. These conditions involve the entering into an agreement between the taxpayer and an intermediary who is unrelated to the taxpayer. Certain legal formalities must be met drafting both the purchase agreement and the arrangements between the intermediary and the taxpayer.
A traditional like-kind exchange involves selling the old aircraft first, then identifying its replacement within 45 days, and finally closing the purchase within 180 days. A “reverse” like-kind exchange involves acquiring the replacement aircraft first and selling the relinquished aircraft later. In 2000, the IRS published a revenue procedure setting forth safe harbor rules for reverse like-kind exchanges. The safe harbor involves meeting 45-day and 180-day tests similar to traditional exchanges. The safe harbor also includes rules providing taxpayers with maximum economic flexibility, thus making safe harbor exchanges attractive from a transaction-planning perspective.
In a slow aircraft marketplace, the requirement to sell the old aircraft within 180 days may become significant. For this reason, taxpayers may consider ways to extend the time limit by performing exchanges outside the safe harbor. Although the safe harbor itself is relatively recent, taxpayers have been performing reverse exchanges, and courts have been upholding them, since over twenty years prior to the safe harbor’s existence. Furthermore, the IRS has specifically stated that the fact that a transaction may fall outside this particular safe harbor shall not be used to infer that the exchange is not entitled to “tax free” treatment.
Why A Reverse Like-Kind Exchange is Particularly Valuable in this Market
When upgrading in a market that has suffered significant price drops, the savings on your replacement aircraft will usually more than exceed the loss in equity of your old aircraft. However, due to the large number of aircraft available, there appears to be an inordinate number of sellers desperate to move their aircraft at below what one might believe to be fair market value. These sellers would generally not be inclined to accept a trade-in, but instead are seeking to get rid of their aircraft investment. A reverse like-kind exchange enables the purchaser to acquire a very aggressively priced aircraft while ultimately disposing of his existing aircraft in an orderly fashion.
A final note of caution: it is important that the intermediary be familiar with aircraft transactions. In addition to federal tax considerations, state sales and use tax and FAA issues also play roles in aircraft exchange transactions. The burdens imposed by the Federal Aviation Administration relating to operational control of the aircraft significantly limit the acceptable arrangements that may be put in place between the taxpayer and intermediary.
Contributions to this article were made and edited by Louis M. Meiners, Jr., CPA