A partnership (lessor) owns multiple aircraft that it leases to another partnership (lessee). The aircraft are used principally by two of lessee’s senior executives. They use the aircraft for business purposes and personal purposes. The executives report the value of personal use as compensation. The executives own interests in lessee, and each also owns 50% of lessor. The lessor exchanges a relinquished aircraft for a replacement aircraft. Both aircraft were leased under a so-called “dry” lease – the lessee provides flight crew and other services pertaining to the aircraft. As to the relinquished aircraft, the lease payments approximated the fair market rental value of the aircraft. As to the replacement aircraft, the lease payments were below fair market rental value. The lease payments were designed to cover the aircraft’s carrying costs, but were not designed to generate meaningful economic profit. The issue in Chief Counsel Advice 201601011 was whether the lessor held the relinquished and replacement aircraft “for productive use in a trade or business” under the like-kind exchange rules of Section 1031. The IRS’s field position was that “held for productive use in a trade or business” is not defined in the Code or Treasury regulations. The field relied on the not-for-profit (hobby rules) law of Section 183. IRS Chief Counsel found no authority suggesting that Section 183 law should be used to evaluate whether property is held for productive use under Section 1031. Chief Counsel stated that property could be held for productive use in a business even though the business holds and uses property in a way that, if the use of the property were viewed as an activity, did not and could not generate a profit. Chief Counsel stated that the lessor’s lack of intent to make a economic profit on the aircraft rental does not establish that the aircraft fails the productive use in a trade or business standard of Section 1031. It noted that for many reasons businesses opt to hold property, especially aircraft, in a separate entity. It observed that the related lessee operated a legitimate business enterprise that required the private aircraft to be available to its senior executives both for business travel and as an employment perk. Chief Counsel stated that were it to disallow Section 1031 treatment based on the entity structure here, businesses would be forced to structure similar transactions in inefficient and potentially risky ways to achieve Section 1031 treatment. Chief Counsel ruled against the IRS field position in concluding that the aircraft are held for productive use in a trade or business.
Home » EXCHANGED PROPERTY HELD IN NOT-FOR-PROFIT ACTIVITY QUALIFIES AS LIKE-KIND EXCHANGE – Posted March, 2016