Could a contractor partnership distribute equipment, vehicles, and an indebted aircraft to equal partners who immediately contributed them to their equally owned corporation?

Plain-English summary

An equal two-person general-contractor partnership proposed distributing category 3 construction equipment and vehicles and category 4 office furniture and equipment one-half to each partner. Category 3 included a Beech aircraft carrying $435,160 of debt. Each partner would assume half that debt.

Immediately afterward, the partners would contribute their undivided halves to a general-contractor corporation they also owned 50/50. The corporation would assume all aircraft debt, but the partners would receive no additional stock or equity. The temporary partner-level step was proposed for federal income-tax purposes.

For property other than vehicles and aircraft, both steps could qualify as occasional sales if neither the partnership nor either partner made a permit-triggering series. One partner's interests in separately permitted entities did not personally make him a permit holder if those entities were distinct statutory persons.

Vehicles and the aircraft required section 6281's separate exemption. Counsel conditionally found both steps exempt based on at least 80 percent of the relevant business tangible property transferring and equal ultimate ownership remaining intact at each step. Category 5's actual use and omitting the aircraft could defeat the property percentage.

As an alternative, if the aircraft and related liability were omitted and every remaining category 3 and 4 item moved without consideration, counsel said no sale or purchase would occur. The source does not show that either structure was completed.

Five categories, two transfers, separate exemptions, and source limits

Tax Counsel David H. Levine wrote on August 8, 1988 to R--- R. B---, C.P.A. about B--- C--- Co. and B--- D--- Co., Inc. His analysis used the C.P.A.'s July 8 letter, a July 25 telephone conversation, and documents mentioned but not reproduced.

The partnership and corporation were general building contractors owned equally by T--- B--- and L--- B---. The partnership had held a furniture-store seller's permit about nine years earlier but reportedly had conducted no permit-requiring activity since. The corporation had never held a seller's permit, and Levine expressly assumed it did not conduct a permit-requiring business.

The five property categories were: categories 1 and 2, real estate holdings; category 3, business construction equipment and vehicles, including the indebted Beech aircraft; category 4, business office furniture and equipment; and category 5, property used by individual partners personally or for investment. Counsel presumed category 5 was not used in partnership operations but later warned that a contrary classification could change the 80-percent result.

L--- B--- also was sole shareholder of a corporation owning a 50-percent interest in a permitted gas-station partnership. He previously held personal 50-percent partnership interests in a car-parts store and clothing store; both held permits and had gone out of business. T--- B--- apparently had no other permit-requiring business. Levine used sections 6005 and 6066 to distinguish a partner from partnerships and corporations holding their own permits.

The proposal would distribute categories 3 and 4 to the partners as equal undivided interests. Each would assume half the $435,160 aircraft debt. They would immediately contribute those interests to the corporation, which would assume the full debt without issuing more stock or equity.

For nonvehicle and nonaircraft property, section 6006.5(a), section 6367, and Regulation 1595(a)(1) controlled. Levine described three or more sales in any rolling 12 months as generally requiring a permit. One subject sale plus more than one additional sale could therefore disqualify the partnership. Relevant other sales could include model-home furniture and category 5 personal or investment property. The same series analysis separately applied to each partner, including L--- B---'s sale of an interest in a partnership owning tangible property under the source's citation to Corporations Code section 15025.

On the assumption that no transferor made a disqualifying series, the two nonvehicle transfer steps were occasional and exempt. The source gives no complete past or future sales histories for the partnership or either partner, sale counts, dates, proceeds, permits, model-home records, or ownership-interest transfers.

Section 6367 did not supply the occasional-sale exemption for vehicles and aircraft. Levine instead applied section 6281 and Regulation 1595(c), using Regulation 1595(b)(2)'s definitions: at least 80 percent of business tangible personal property had to transfer, and at least 80 percent of its ultimate ownership had to remain unchanged.

For the first step, counsel said the supplied description and documents did not make the property percentage entirely clear and expressly assumed the threshold was met. If category 5 was actually used in partnership business, or if the aircraft was omitted, he said substantially all partnership business property apparently would not transfer. Equal partner ownership remained 50/50 before and after distribution.

For the second step, 50/50 partner ownership became 50/50 corporate stock ownership, satisfying the ownership condition. Counsel separately assumed the assets were at least 80 percent of the tangible property each partner held or used in business. The source supplies no category schedule, value, appraisal, use evidence, numerator, denominator, calculation, or ownership documentation for either step.

Counsel also answered the alternative proposal. If the aircraft did not transfer, its debt was not assumed, and all remaining category 3 and 4 property moved without consideration, sections 6006(a) and 6010(a) meant no sale or purchase occurred. Sections 6051 and 6201 therefore imposed no sales or use tax on those transfers. This alternative depended on consideration actually being absent; the source provides no agreements or accounting entries.

The PDF omits the request, conversation record, and referenced documents; entity formation, partnership and stock records; seller's permits and histories; the furniture-store timeline; related-entity and former-business records; all asset, title, registration, location, use, value, and percentage schedules; aircraft title, appraisal, debt instrument and assumption agreements; model-home and other sales histories; transfer and contribution agreements; consideration and accounting records; federal income-tax analysis; completed transactions; returns, audit, assessment, payment, refund, administrative action, appeal, or outcome.

The live annotation preserves the five categories, equal partnership and corporate ownership, category 3 and 4 transfers, aircraft debt, no added equity, assumed absence of other sales, occasional-sale result, and property and ownership conclusions. It omits the C.P.A., companies, request, call and documents; both contractor businesses; prior and related permit histories; $435,160 debt amount; federal income-tax purpose; rolling sales-series rule and examples; sections 6005, 6066 and Corporations Code section 15025; the distinct-person analysis; section 6281's separate vehicle-and-aircraft path; both 80-percent definitions; counsel's uncertainty and assumptions about the property calculations; category 5 and aircraft risks; the no-aircraft/no-consideration alternative; missing records; and absence of a completed transaction or outcome. It states category 5 was not used in partnership operations where the letter says that was presumed.

What this means for you

Partnerships moving operating assets into a corporation

Analyze nonvehicle property separately from vehicles and aircraft, and support each transferor's sales history, business-property pool, percentage, ownership, and consideration at each step.

Accountants and tax professionals

Review the complete rolling 12-month sales history, property classified as business versus personal or investment, debt assumptions, and each owner's interests before and after transfer.

Common questions

Q: Did the partners' interests in other permitted entities make them sellers personally?
A: No. The letter treated the separate partnerships and corporations as distinct persons holding their own permits.

Q: What protected the vehicles and aircraft?
A: Section 6281 applied only on counsel's assumptions that at least 80 percent of relevant business property moved and at least 80 percent of ultimate ownership remained unchanged at each step.

Q: Why could category-5 property matter?
A: If personal or investment property was actually used in the partnership business, it could reduce the transferred percentage below 80 percent.

Q: What if the aircraft was excluded?
A: Counsel said the property test apparently would fail; but if the related liability also stayed out and every remaining category 3 and 4 item moved without consideration, no sale or purchase would occur for those items.

Q: How many other sales could defeat the nonvehicle exemption?

A: The letter described three or more sales in a rolling 12-month period as the general permit threshold, so the subject sale plus more than one additional sale could be disqualifying.

Q: Was category 5 conclusively personal or investment property?

A: No. Counsel presumed that classification and warned that business use could cause the first 80-percent property test to fail.

Q: Did the source prove both 80-percent calculations?

A: No. Counsel said the first was not entirely clear and assumed it, then also assumed the partner-level property threshold for the second step.

Q: Did the proposed transfers occur?

A: The source gives no executed agreements, title changes, debt assumptions, returns, assessment, or later outcome.

Citations and references

• California Revenue and Taxation Code §§ 6005, 6006(a), 6006.5(a), 6010(a), 6051, 6066, 6201, 6281, and 6367
• California Corporations Code § 15025 — cited for a partner's ownership of specific partnership property
• California Sales and Use Tax Regulation 1595(a)(1), (b)(2), and (c)
• July 8, 1988 C.P.A. letter, July 25 telephone conversation, and supplied documents — identified but not included
• Entity, ownership, permit, sales-history, asset, title, registration, use, value, aircraft, debt, percentage, transfer, contribution, consideration, accounting, federal-tax, return, audit, tax, administrative, and outcome records — described or implicated but not included

Verbatim support

From the official August 8, 1988 David H. Levine letter:

Generally, three or more sales within twelve months is a series of sales requiring the seller to hold a seller's permit. (Reg. l595(a)(l).)

Although it is not entirely clear from the description and documents you have provided, it appears that at least 80% of the tangible personal property used by the partnership in the course of its business activities is being transferred to the individual partners. For purposes of this opinion, I assume this understanding is accurate.

Assuming the transfer is part of a transfer of at least 80% of the tangible personal property held or used by each of the individual partners in the course of their business activities, their transfer to the corporation would be substantially all the property held or used by them in the course of such activities.

If all tangible personal property, except the aircraft, listed in your categories 3 and 4 are transferred without consideration for the transfer, no sale or purchase would occur.

Source

• Annotated Legal Opinions collection: CDTFA Annotated Legal Opinions
• Live annotation: Annotation 395.1313
• Original supporting opinion: 395.1313 PDF

Original ruling text

395.1313

STATE OF CALIFORNIA

STATE BOARD OF EQUALIZATION

August 8, 1988

R--- R. B---, C.P.A.
I---, L---, B---, D---, B--- & Co.
P.O. Box XXXX
---, CA XXXXX
Re:

B--- C--- Co.
B--- D--- Co., Inc.

Dear Mr. B---:
This is in response to your letter dated July 8, 1988, regarding the application of sales or use tax to a transfer of tangible personal property between B--- C--- Co. (“partnership”) and B--D--- Co., Inc. (“corporation”). The information set forth below is based on your letter and our telephone conversation of July 25, 1988. The partnership is a general building contractor. About nine years ago, it held a seller’s permit for the operation of a furniture store. Since that time, it has engaged in no activity requiring the holding of a seller’s permit. The partnership is owned equally by T--- B--- and L--B---. The partnership owns property you have divided into five categories. Categories 1 and 2 are real estate holdings. Category 3 is construction equipment and vehicles used by the partnership for business purposes, and includes a Beech aircraft for which the partnership is indebted $435,160. Category 4 is office furniture and equipment used by the partnership for business purposes. Category 5 is property used by the individual partners for personal use or investment. The corporation is also a general building contractor. T--- B--- and L--- B--- each own 50% of the stock of the corporation. The corporation has never held a seller’s permit, and I assume it is not engaged in a business requiring it to hold a seller’s permit. L--- B--- is also the sole shareholder of a corporation which owns a 50% partnership interest in an [gas] station which holds a seller’s permit. L--- B--- also held a 50% partnership interest in a car parts store and a 50% partnership interest in a clothing store. Each of those businesses held a seller’s permit, but has now gone out of business.

R--- R. B---, C.P.A.

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August 8, 1988
395.1313

The parties are contemplating the following transactions. All assets listed in categories 3 and 4 wou1d be distributed to T--- B--- and L--- B---, an undivided one-half interest in these assets to each partner. Since categories 1 and 2 are real estate holdings and category 5 property is presumably not used in the operation of the partnership’s business, the category 3 and 4 property transferred appears to be all the tangible personal property used by the partnership in the course of its business operations. Each partner will assume liability for one-half of the indebtedness on the Beech aircraft. Immediately after these transfers, T--- B--- and L--- B--- will each contribute his undivided one-half interest in the transferred assets to the capital of the corporation. The corporation will then assume the entire indebtedness on the Beech aircraft. Neither T--- B--- nor L--- B--- will receive additional stock or other equity interest in the corporation as a result of these transfers. (The transitory transfers of assets and liability to the partners is being done for federal income tax purposes.) You ask for our conclusion that the above transfers are not subject to sales or use tax. Alternatively, you ask for our conclusion that, except for the transfer of the aircraft and related liability, the transfers will not be subject to sales or use tax. Discussion A retailer’s retail sale of tangible personal property in California is subject to sales tax unless specifically exempted by statute. (Rev. & Tax. Code § 6051.) Alternatively, the use of property in California purchased from a retailer is subject to use tax unless specifically exempted by statute. (Rev. & Tax. Code § 6201.) The relevant exemptions with respect to these transfers are provided by Revenue and Taxation Code Sections 6281 and 6367. Section 6367 exempts occasional sales as defined by Revenue and Taxation Code Section 6006.5 from sales and use tax, except sales of, as relevant here, vehicles and aircraft. Section 6281 exempts sales of vehicles and aircraft from sales and use tax under specified circumstances. 1.

Sales of tangible personal property except vehicles and aircraft

Section 6006.5(a) defines occasional sale as:
“A sale of property not held or used by a seller in the course of activities for which he or she is required to hold a seller’s permit or permits or would be required to hold a seller’s permit or permits if the activities were conducted in this state, provided the sale is not one of a series of sales sufficient in number, scope, and character to constitute an activity for which he or she is required to hold a seller’s permit or would be required to hold a seller’s permit if the activity were conducted in this state.”

R--- R. B---, C.P.A.

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August 8, 1988
395.1313

Generally, three or more sales within twelve months is a series of sales requiring the seller to hold a seller’s permit. (Reg. l595(a)(l).) Thus, if the partnership makes more than one sale in addition to the subject sale during any twelve month period during which the subject sale occurs, that sale would be one of a series of sales requiring the partnership to hold a seller’s permit. Such a twelve month period could be the twelve months ending with the subject sale, the twelve months beginning with the subject sale, or, for example, the twelve months beginning six months before the subject sale occurs. The other sales which would cause the partnership to need to hold a seller’s permit would include, for example, sales of furniture displayed in model homes and sales of the property used by the partners for personal use and investment. You state that the partnership is not engaged in a business requiring a seller’s permit. Assuming the sale is not one of a series of sales requiring the partnership to hold a seller’s permit, the partnership’s sale to the partners would be an occasional sale under Section 6006.5(a). As an occasional sale, except with respect to the sale of the vehicles and aircraft (discussed below), the sale from the partnership to the individual partners is exempt from sales or use tax. (Rev. & Tax. Code § 6367.) The same analysis discussed above applies to the sale by the individual partners to the corporation. T--- B--- is apparently not involved in any other business requiring the holding of a seller’s permit. Assuming his sale to the corporation is not one of a series of sales for which he would be required to hold a seller’s permit, his sale of the tangible personal property, except the sale of the vehicles and aircraft, to the corporation would be an occasional sale exempt from sales or use tax. L--- B--- is apparently also not involved in any other business requiring him to hold a seller’s permit. His ownership interest in other entities required to hold a seller’s permit does not mean he is engaged in a business requiring the holding of a seller’s permit provided the other entities are “persons”·required to hold seller’s permits in their own names. (Rev. & Tax. Code §§ 6005 (“persons” includes partnerships and corporations), 6066.) Assuming also that his sale to the corporation is not one of a series of sales for which he would be required to hold a seller’s permit (which would include the sale of an interest in a partnership owning tangible personal property since a partner owns specific partnership property pursuant to Corporations Code Section 15025), L--- B---’s sale of tangible personal property, except the sale of the vehicles and aircraft, to the corporation would be an occasional sale exempt from sales or use tax. 2.

Sales of Vehicles and Aircraft

The sale of the vehicles and aircraft is exempt from sales or use tax if it is included in a transfer of all or substantially all property held or used in the course of business activities of the person selling the property and the real or ultimate ownership of the property is substantially similar to that which existed before such transfer. (Rev. & Tax. Code § 6281, Reg. 1595(c).) “Substantially all the property” means 80% or more of all tangible personal property held or used in the course of the business activities of the person selling the property. The real or ultimate ownership is “substantially similar” to that which existed before a transfer if 80% or more of that ownership of tangible personal property is unchanged after the transfer. (Reg. 1595(b)(2).) For

R--- R. B---, C.P.A.

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August 8, 1988
395.1313

purposes of this exemption, stockholders and partners are regarded as having the real or ultimate ownership of the property of the corporation or partnership. (Rev. & Tax. Code § (6281.) Although it is not entirely clear from the description and documents you have provided, it appears that at least 80% of the tangible personal property used by the partnership in the course of its business activities is being transferred to the individual partners. For purposes of this opinion, I assume this understanding is accurate. Based on this assumption, substantially all of the property held in the partnership’s business activities is being transferred. Please note, however, that if the tangible personal property in category 5 is properly regarded as used in the course of the partnership’s business activities, it appears that substantially all of the property used by the partnership in the course of its business activities would not be transferred. Further, if the aircraft is not transferred, substantially all of the property used by the partnership in the course of its business activities would not be transferred. Before the transfer, each partner apparently owns 50% of the partnership and would therefore be regarded as owning 50% undivided interest in all assets. After the transfer, each partner will still own a 50% undivided interest in all tangible personal property transferred. Therefore, the ownership is substantially similar to that which existed before the transfer. Since both conditions of the exemption would be satisfied, the transfer of the vehicles and aircraft to the individual partners would be exempt from sales and use tax under Section 6281. A similar analysis applies to the transfer by the individual partners of the vehicles and aircraft to the corporation. Since T--- B--- and L--- B--- each own 50% of the stock of the corporation, after the transfer they will each be regarded as owning 50% of the tangible personal property transferred to the corporation. (Rev. & Tax. Code § 6281.) Since they each own 50% of those assets before the transfer and 50% after the transfer, the ownership would be substantially similar. Assuming the transfer is part of a transfer of at least 80% of the tangible personal property held or used by each of the individual partners in the course of their business activities, their transfer to the corporation would be substantially all the property held or used by them in the course of such activities. Based on the assumptions made above, the sale by L--B--- and T--- B--- to the corporation would be exempt from sales or use tax. (Rev. & Tax. Code § 6281.) In case one of the understandings or assumptions upon which this opinion is based is incorrect, I will also respond to your other question. If the aircraft is not transferred and its related liability not assumed, there would apparently be no consideration for any of the transfers. A “sale” and “purchase” is a transfer of tangible personal property for a consideration. (Rev. & Tax. Code §§ 6006(a), 6010(a).) If all tangible personal property, except the aircraft, listed in your categories 3 and 4 are transferred without consideration for the transfer, no sale or purchase would occur. Since there would be no sale or purchase, the transfer would not be subject to sales or use tax. (See Rev. & Tax. Code §§ 6051, 6201.)

R--- R. B---, C.P.A.

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If you have further questions, feel free to write again.
Sincerely,

David H. Levine
Tax Counsel
DHL:ss

August 8, 1988
395.1313