Tax-Free Exchanges of Aircraft Under Section 1031

Planning Considerations: Sales Tax
Under Section 1031
© 1999 KEITH G. SWIRSKY

Besides the many issues discussed above relating to the federal tax treatment of like-kind exchanges, such transactions also merit consideration from the perspective of state tax issues. The most prominent of these is state sales and use tax. In the case of aircraft, all but six states impose such a tax, with rates ranging from 2% to more than 8% (inclusive of local taxes).

Generally, property that is sold in a state and used there by the purchaser will be subject to sales tax, while property that is sold in one state for use in a second state will be subject to use tax in the latter state, and may be subject to sales tax in the former state. Within a single state, however, the sales tax and use tax are virtually identical in every respect except name. Many states provide a variety of exemptions from sales and use tax; a common exemption in most states is one for aircraft that is used by a licensed air carrier which transports persons for hire in interstate commerce.

Another useful exemption, and one that could apply to most like-kind exchanges is the trade-in exemption. The trade-in exemption reduces the amount of tax imposed on a transaction, as follows: State sales and use tax is generally computed as a percentage of the purchase price of the property. However, where trade-in property is paid as part of the purchase price, the value of such trade-in property is deducted from the purchase price. As a result, in a like-kind exchange, the sales and use tax would generally be imposed only on an amount representing the difference in value between the relinquished property and the replacement property. Unfortunately, this favorable exemption may not always be available in an exchange involving a qualified intermediary. Some states have indicated that they would grant a trade-in exemption to such an exchange, while other states have determined that they would deny a trade-in exemption in a transaction involving a qualified intermediary. See, Hutton v. Johnson, 1997 Tenn. LEXIS 569 (Filed Nov. 17, 1997).

There are some other exemptions from state sales and use taxes that may be available for transfers of aircraft depending on the facts and circumstances of the particular transaction and the jurisdictions in which the transfer occurs and the aircraft is utilized. State tax planning, however, will have to be reconciled with federal tax and regulatory planning. In short, in some jurisdictions, a taxpayer engaging in a like-kind exchange may be forced to choose between benefiting from a state tax exemption and achieving the certainty of federal tax relief under Section 1031. Fortunately, taxpayers do possess certain planning tools, such as single member LLCs and deferred exchanges, to address some of their concerns.

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