A Tantalizing Option for Real Property and Aircraft Transactions
What do aircraft and real property transactions have in common? Both must be planned and structured carefully to mitigate tax impacts when possible. Whether referred to as a “1031,” “like-kind” or “Starker” exchange, it is an approach often used by my real estate and aviation clients to add value to their investment transactions.
A Brief History: 1031 Exchanges
1031 Exchanges are not new – they have existed since passage of the National Revenue Act of 1921. They can be used for a wide variety of real and personal property (artwork, livestock, automobile fleets, copyrights, trademarks, domain names, aircraft engines, railroad rolling stock, shipping vessels, business assets… and much more).
The rules vary depending upon the type of property involved and my clients most often elect to use 1031 exchange structures in real estate and business aircraft transactions.
The Benefit: Deferral of Capital Gains Taxes and Depreciation Recapture
1031 exchanges allow the payment of capital gains tax on qualifying business or investment property sales to be deferred. They allow you to reinvest sales proceeds, which would otherwise have to be paid in taxes to the government. 1031 exchanges enable you to more efficiently utilize your cash. Like a 401(k), they allow your investment to grow tax-deferred.
The basic concept behind 1031 exchanges is that, if you reinvest sales proceeds in “like-kind” property, then you did not actually realize economic gain from the sale. The sales proceeds that would typically be used to pay capital gains tax were reinvested, so it would be unfair for you to be forced to pay capital gains tax at that time.
There is no limit to the number of times you can do a 1031 exchange, so you use them repeatedly. For example, a real estate investor could structure every property disposition as a 1031 exchange. Although there may have a profit on each sales transaction, payment of capital gains taxes on the transactions would be deferred until sales proceeds were taken in cash and not fully used to purchase like-kind properties.
The Basics: General Requirements
There are many facets to analyze in 1031 exchange transaction and this article is meant to provide a general educational overview. We will explore the basics of 1031 exchange requirements as well as forward and reverse exchanges in future postings.
If you believe a 1031 exchange structure should be considered in your property transaction, it’s important that you notify legal and tax advisers as soon as possible. Exchange language needs to be built into your purchase and sales agreements, and there is additional tax planning needed that is best addressed as far in advance as possible and particularly before a purchase/sales agreement is executed.