Related-party aircraft qualify as held for productive business use

Plain-English summary

A partnership exchanged aircraft that it owned and leased to a related operating business whose executives used them for business and personal travel. The leases covered carrying costs but were not designed to produce a meaningful economic profit for the aircraft-owning partnership. Chief Counsel advised that the aircraft were still held for productive use in a trade or business under IRC § 1031 because they served the legitimate operating needs of the related business, and the profit-motive standards of IRC § 183 did not control that question. The advice assumed the partnership was valid and addressed only the productive-use requirement, while noting that other provisions such as IRC §§ 280F and 482 might affect the tax treatment.

Ruling snapshot

• Question: Are aircraft leased to a related operating business held for productive use under IRC § 1031 when the leases are not designed to generate an economic profit for the owner?
• Outcome: Advice given
• Key authorities: IRC §§ 183, 1031(a)(1); Wagensen v. Commissioner, 74 T.C. 653 (1980)

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201601011
       Release Date: 12/31/2015
       CC:ITA:B04: S Toomey
       POSTF-139336-14

UILC: 1031.01-00

date: August 24, 2015

 to:   Shelia D. Harvey
       Senior Counsel
       (LB&I - Houston Gr2)

from: Stephen J. Toomey
Senior Counsel
Office of Associate Chief Counsel
(Income Tax & Accounting)

subject: Section 1031 Aircraft Exchange

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.

       LEGEND

       P                       =   --------------------------
       O                       =   ---------------------------------------
       A                       =   ------------------------
       B                       =   --------------------
       Year 1                  =   --------------------------------------------------
       Relinquished Aircraft   =   --------------------
       Replacement Aircraft    =   -------------------

POSTF-139336-14 2

ISSUE

Does P hold relinquished aircraft and replacement aircraft “for productive use in a trade
or business” within the meaning of § 1031 of the Internal Revenue Code if the aircraft,
which are leased to a related entity that that is owned by the same individuals who own
P, are P’s only operating assets and do not generate an economic profit for P?

CONCLUSION

P holds both the relinquished and replacement aircraft “for productive use in a trade or
business” within the meaning of § 1031.

FACTS

Partnership P owns multiple aircraft which are leased to Partnership O. O is the primary
business entity of the O group of entities, which includes P and other entities. O’s
business activities involve air travel, particularly by its executives. For both business
and legal reasons, the aircraft are owned by P, in an entity separate from the main
business entity, O, and leased to O. The aircraft are the only operating assets of P, but
P also owns interests in other entities in the O group of entities. The aircraft are
principally used by two of O’s senior executives—A and B. A and B use the aircraft
variously for business purposes and for personal purposes. Thus, the aircraft serve a
business purpose for O both in terms of business travel and as an employment perk for
its senior executives. To the extent A and B use the plane for personal purposes, they
include the required amount in income as compensation under IRS regulations. A and
B, who own interests in O through wholly-owned entities, also own 50 percent each of P
through wholly-owned entities.

In Year 1, P exchanged the relinquished aircraft for the replacement aircraft. Both the
relinquished and replacement aircraft were leased under a so-called “dry” lease, under
which the lessee provides flight crew and other services pertaining to the aircraft. The
lease payments for the relinquished aircraft approximated the fair market rental value of
the aircraft whereas the lease payments for the replacement aircraft were below market.
Nevertheless, in both cases, the lease payments were designed to cover the aircraft’s
carrying costs and were not designed to generate meaningful economic profit.

The field’s position is that P did not hold either the relinquished or replacement aircraft
for productive use in a trade or business. Because the term “held for productive use in
a trade or business” is not defined in the Code or Regulations, the field relies on § 183
and accompanying cases and regulations to determine whether P held the aircraft for
productive use in a trade or business. See, e.g., Treas. Reg. §§ 1.183-2(b) and 1.183-
1(d)(1); Campbell v. Commissioner, 868 F. 2d 833 (6th Cir. 1989), aff’g. in part and
rev’g. in part T.C. Memo 1986-569. In addition, the field contends that, in making the
evaluation under § 183, entities should be examined solely on an entity by entity basis,
and the profit motive of one entity should not be attributed to another entity, even if the
two entities are closely related. See, e.g., United States v. Basye, 410 U.S. 441 (1973);
POSTF-139336-14 3

Moline Properties v. Commissioner, 319 U.S. 436 (1943); Polakof v. Commissioner, 820
F. 2d 321 (9th Cir. 1987), cert. denied, 484 U.S. 1025 (1988). Using the standards
under § 183, the field concludes that P did not hold the aircraft for productive use in a
trade or business.

Finally, the field did not raise the issue of whether P is a valid partnership and not a
sham entity. If P is a sham entity then A and B, not P, are the owners of the aircraft. In
that case, our analysis would be different than provided below and the conclusion may
be different as well. Thus, our assumption is that P is a valid partnership.

LAW AND ANALYSIS

Section 1031(a)(1) provides that: “No gain or loss shall be recognized on the exchange
of property held for productive use in a trade or business or for investment if such
property is exchanged solely for property of like kind which is to be held either for
productive use in a trade or business or for investment.”

Whether the property is held for productive use in a trade or business or for investment
is a question of fact. The manner in which the relinquished property is held at the time
of the exchange controls not the manner in which it was held when acquired. Similarly,
replacement property is held for productive use in a trade or business or held for
investment if it is so held at the time of acquisition. Wagensen v. Commissioner, 74
T.C. 653 (1980).

Section 183 applies to limit the deductions of an individual or an S corporation engaging
in an activity without a profit motive. There is no authority suggesting that the standards
of § 183 should be used to evaluate whether property is held for productive use for
purposes of § 1031. Consequently, we do not agree that the § 183 standards should be
used to evaluate whether the aircraft are property held for productive use in a trade or
business.

The facts indicate that the rent P charges O for use of the relinquished property and the
replacement property is insufficient for P to make an economic profit on the aircraft
rental to O. However, many businesses hold and use properties in a way that, if the use
of the property were viewed as an activity, do not and could not generate profit.
Nevertheless, the property itself is held for productive use in that business. Thus, P’s
lack of intent to make an economic profit on the aircraft rental does not establish that
the aircraft fails the productive use in a trade or business standard of § 1031. In
addition, we agree with the field that A’s and B’s use of the property for personal
purposes is not relevant in determining whether P holds the aircraft for productive use in
a trade or business.

Moreover, it is important to point out that businesses, for any number of reasons, opt to
hold property, especially aircraft, in a separate entity. In the present case, O, which
operates a legitimate business enterprise, requires private aircraft to be available to its
POSTF-139336-14 4

senior executives, both for business travel and as an employment perk. However, for
business and legal reasons, the aircraft are owned not by O but by P, a related entity. If
O owned the aircraft, or was the 100 percent owner of P, we doubt that the field would
have raised the issue of whether the aircraft were held for productive use in a trade or
business. Were we to disallow § 1031 treatment based on the entity structure
presented here, businesses would be forced to structure their transactions in inefficient
and potentially risky ways to achieve § 1031 treatment. Thus the entity structure in the
present case should not be used as grounds that the aircraft fails to qualify as property
held for productive use in a trade or business.

In sum, O operates a legitimate business enterprise and requires private aircraft to be
available to its senior executives. For business and legal reasons, O has structured its
affairs so that the aircraft are owned through P and leased to O for an amount not
intended to generate a profit for P. On these facts, the aircraft are held for productive
use in a trade or business.

We are sensitive to two facts raised by the field: P charges below-market rent for the
replacement aircraft and A and B, rather than O, own P. While these facts do not
disqualify the property from being held for productive use in a trade or business for
purposes of § 1031, it may be that other tax provisions such as § 280F or 482 may
apply to disallow tax benefits or impose a tax treatment different from the treatment
claimed by P, O or A and B.

Finally, our analysis extends only to whether the relinquished and replacement aircraft
meet the held for productive use in a trade or business requirement in § 1031(a). We
do not express or imply an opinion on whether the exchange met the other
requirements under § 1031 to qualify as a like-kind exchange. Nor do we express or
imply an opinion regarding other tax aspects of the transaction.

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