Tax-Free Exchanges of Aircraft Under Section 1031
Under Section 1031
© 1999 KEITH G. SWIRSKY
If a taxpayer transfers more than one relinquished property in the same deferred exchange, and the relinquished properties are transferred on different dates, then the 45-day identification period and the 180-day exchange period are determined by reference to the earliest date in which a transfer occurs. In order to avoid the effect of this rule, it may sometimes be advisable to separate a multi-property transfer into independent transactions with respect to each of the relinquished properties.It is now accepted that a like-kind exchange may be non-simultaneous or "deferred." The Code and Regulations provide extensive guidance on the proper structuring of deferred exchanges.
A. Time Limitations
In a transaction that is structured as a deferred exchange, the replacement property is acquired after closing on the sale of the relinquished property. Section 1031 requires that replacement property in a like-kind exchange must be (1) identified as replacement property on or before midnight on the forty-fifth day after the date on which the taxpayer transfers the relinquished property, and (2) received on or before the earlier of (i) midnight of the one hundred eightieth day after the date on which the taxpayer transfers the relinquished property, or (ii) the due date (determined with regard to extensions) for the taxpayer's return for the taxable year in which transfer of the relinquished property occurs. According to the Regulations, to properly identify replacement property, the property must be unambiguously described, in a written document or agreement; for example, if the taxpayer is exchanging aircraft, this requirement will be satisfied by a general description by type and manufacturer and serial number specification of the engines.
B. Identification of Multiple Properties
The maximum number of replacement properties that a taxpayer may identify are: (a) three properties, without regard to their fair market value, or (b) any number of properties as long as their aggregate fair market value as of the end of the forty-five-day identification period does not exceed 200% of the aggregate fair market value ("FMV") of all relinquished properties as of the date the relinquished properties were transferred by the taxpayer. In the case of replacement property being modified or enhanced, the fair market value for purposes of the 200% rule is its estimated fair market value as of the date it is expected to be received by the taxpayer.
If, as of the end of the identification period, the taxpayer identifies more replacement properties than is permitted, the taxpayer generally is treated as if no replacement property had been identified. Despite this rule, the taxpayer is treated as having properly identified (a) any replacement property received before the end of the identification period, and (b) any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if before the end of the exchange period, identified replacement property with a FMV of at least 95% of the aggregate FMV of all identified replacement properties is received.
C. Regulatory Safe Harbors
In an effort to provide clear rules for deferred transactions, the Regulations provide a number of so-called "safe harbors," i.e., specific procedures which, if properly followed, render an exchange immune from challenge by the IRS. The safe harbors protect a taxpayer, for example, from an argument by the IRS that the exchange is really a sale, based upon such general principles as agency and constructive receipt. Tax advisers usually seek to comply with the deferred exchange safe harbor because the rules outside the safe harbors are uncertain. Indeed, it is arguable that meeting the requirements of the regulations are the exclusive means to qualify a non-simultaneous, forward Starker transaction (i.e. the relinquished property is transferred prior to receipt of the replacement property) for 1031 tax-deferred treatment. See, Preamble, former Prop. Reg. 1.1031(a) (stating that the Treasury expected transactions falling outside of the safe harbor to be carefully scrutinized). In practical terms, this means that a trade-in of an aircraft to a manufacturer prior to delivery by that manufacturer of a new aircraft may not qualify for 1031 treatment unless the specific requirements of the regulations are met.
1. Use of A Qualified Intermediary
Under one safe harbor, a taxpayer may transfer the relinquished property to the taxpayer's agent provided (a) the agent is a "qualified intermediary" and (b) the taxpayer's rights to receive money or other property from the qualified intermediary are limited to certain specified circumstances. A qualified intermediary is a person who is not the taxpayer or a "disqualified person" (defined below) and who, for a fee, enters into an agreement with the taxpayer, and as required by the agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and then transfers the replacement property to the taxpayer. The transfer of property in a deferred exchange that is facilitated by the use of a qualified intermediary may occur via a "direct deed" of legal title by the current owner of the property to the ultimate owner.
2. Use of Qualified Escrow Accounts and Qualified Trusts
A second safe harbor relates to the use of qualified escrow accounts or trusts for the proceeds from the sale of the relinquished property. It is necessary that the taxpayer who is transferring relinquished property not receive, actually or constructively, the proceeds from the sale of the replacement property. The safe harbor provides that the purchaser of the replacement property may pay for the replacement property at the closing by depositing it into a "qualified" escrow account or "qualified" trust, without the taxpayer constructively receiving the purchase price. For an escrow or trust to be qualified, the escrow holder or trustee must not be the taxpayer or a "disqualified person" (defined below) and the taxpayer's right to receive, pledge, borrow, or otherwise obtain the benefits of the cash or cash equivalent held in the escrow account or by the trustee, must not occur, generally, until the exchange is completed or terminated before closing for non-compliance with the procedural rules.
3. "Disqualified Person" Defined
As referenced above, a qualified intermediary, trustee, or escrowee is a "disqualified person" if:
i. Such person is the "agent" (defined below) of the taxpayer at the time of the transaction; or
ii. Such person and the taxpayer bear any of the following relationships: brother-sister, husband-wife, ancestor-descendant, a more-than-10% stockholder-corporation, a more-than-10% partner-partnership, a corporation-corporation in same controlled group, a partnership-partnership (where one person owns more than 10% of each), a trust fiduciary-trust grantor, a trust fiduciary-trust beneficiary, a corporation-partnership (where one person owns more than 10% of each), or certain other similar relationships enumerated in IRC Section 267(b); or
iii. Such person bears a relationship described in (ii) above to an "agent" (defined below) of the taxpayer at the time of the transaction.
4. "Agent" Defined
Persons who have acted as a taxpayer's employee, attorney, accountant, investment banker or broker, or real estate agent or broker during the two-year period immediately preceding the taxpayer's transfer of the first relinquished property are treated as agents of the taxpayer at the time of the transaction for purposes of (i) above. Performance of services with respect to exchanges intended to qualify under Section 1031, routine financial, title insurance, or escrow or trust services performed for the taxpayer by financial institutions, title insurance companies or escrow companies will be excluded for these purposes.