Update: I have added a comment from an expert on the process behind this ruling.
1031 is one of the few Internal Revenue Code sections, like 401(k) and 501(c)(3), that have worked their way into the vocabulary of people who are not tax geeks. Code Section 1031 provides that when property used in a trade or business or held for investment is exchanged for property of like-kind that will be used in a trade or business or held for investment will only be recognized to the extent that property not of like kind (typically money) is received. Like-kind exchanges are very common with real estate but have a much broader application. ]Airplanes can also be the subject of like-kind exchanges.
What Is It Being Used For?
One of the tricky things about 1031 is the “trade or business or held for investment requirement” – let’s call it the “held for” requirement for short. Revenue Procedure 2008-16 gives a safe harbor for residences providing that the IRS will not challenge a residence as a valid 1031 relinquished property or target if it is rented for at least 14 days in the year before or, in the case of the target, after the exchange and not used personally for more than the greater of 14 days or 10 percent of the number of days during the period.
All Or Nothing
But what about airplanes? Well now we have we Chief Counsel Advice 201605017. The CCA starts off with a clever idea
Is an aircraft owned by an individual that is exchanged for another aircraft in a transaction intended to qualify as a like-kind exchange under § 1031 of the Internal Revenue Code, considered to be two assets, one held for productive use in a trade or business or investment and one held for personal use, if the individual used the exchanged airplane for both personal purposes and for productive use in a trade or business or investment?
It’s kind of amusing to think about swapping the personal part of the aircraft for the business part of the aircraft. Actually sorting that out gives me a headache, so I am glad to say that the Chief Counsel’s office does not approve of it.
For purposes of whether § 1031 applies to an airplane exchange, the exchanged airplane is considered one property that is either held for productive use in a trade or business of for investment, or that is held for personal use.
There is a pretty long discussion of why mainly focusing on the language in the Code implying an all or nothing approach and also mentioning that the Service passed on the opportunity to bifurcate rental properties when it issued Rev Proc 2008-16.
In summary, there is no legal support for treating the relinquished aircraft as two properties for purposes of § 1031. In addition, the position that property either meets or fails to meet the “held for” requirement of § 1031(a)(1) and should not be treated as two properties is consistent with the safe harbor published in Rev. Proc. 2008-16. Consequently, the relinquished aircraft should be treated as one property that either meets “the held” for requirement of § 1031(a)(1) or fails to meet the requirement.
50% Of What?
The whole plane either qualifies or does not qualify, which brings on the next question.
If the airplane is treated as one property for § 1031 purposes and, in the taxable year the relinquished aircraft was exchanged, only X percent of the aircraft’s flights were business or investment related, is the relinquished aircraft property that is held for productive use in a trade or business or for investment?
That part is rather frustrating, since we don’t know what “only X” is. The indication is that it is pretty well under 50%. I’m thinking the field agents were not real happy with the chief counsel’s answer, since they will now get to aggravate the taxpayer with even more questions.
While we agree that the X percent figure cited by the field suggests that the property is not held for productive use in a trade or business or for investment, additional facts should be considered in determining whether the “held for” requirement of § 1031(a) is met. For example, we suggest that the examiner consider: (1) measurement of business/investment use versus personal use based on flight hours, not just flights; (2) percentages of business/investment use versus personal for flights and flight hours for the year before the year of the exchange; and (3) which flights and flight hours were determined to be repositioning flights and the nature of the flight following the repositioning flight. Assuming you determine that over 50 percent of the use of the aircraft was for personal purposes, we agree with your position that the aircraft was not held for productive use in a trade or business of for investment.
I’m wondering if interactions like this is what is really at the root of the interminable IRS scandal now on Day 1030 by TaxProf count. A major complaint of the groups that felt persecuted was that they kept receiving more and more intrusive questions, while waiting on a decision. At least, in this case, it seems that they are ending up with 50% being a determining threshold even if 50% of what is less than clear.
Update
I asked Paul Streckfus of the EO Tax Journal if he saw anything similar between the process in this ruling and the interminable scandal. I wrote him:
I’m wondering it this might be an example of the Chief Counsel not being much help to the field. Agent wants to know how much personal use of a plane blows 1031 and he is sent back to ask more questions. I wonder if that is the dynamic that created the “scandal”.
Paul replied:
It was certainly part of it. I forget how long, the period is noted in my emails, but for a year or two the Tea Party cases were held up while the Office of Chief Counsel reviewed an information letter the EO Division wanted to use as a template. The issue of a template information letter was never resolved but a great deal of time was wasted, and since time had passed, that necessitated, or so it was thought, going back for more current information. So it became a circle, first we don’t have enough information, then we have to review the new information, but now time has passed, so we need more current information, which we then have to review, and on and on, plus we’ve got to get other people’s opinions about how to proceed while all this is going on! There’s obviously an element of CYA (______________) going on, which all government bureaucracies are prone to. — I bowlderized Paul’s spelling out of the acronym.