In its second recent ruling regarding airplanes and a Section 1031 like-kind exchange, CCA 201605017, the Office of the Chief Counsel determined that property should not be bifurcated as held for business or personal reasons. Rather, one treatment must apply to the entire property. Further, the Counsel memo recommends a factual evaluation to determine the holding status.

Facts

A, an individual, has businesses and investments dispersed throughout the United States and owns an aircraft through a disregarded, single-member LLC to service those businesses and investments. The IRS field asserts that a redacted percent of the flights were unrelated to A's business or investments and were thus personal use

In Year 1, A's LLC exchanged the aircraft (relinquished aircraft) for replacement aircraft. The IRS field office asserted that, because only X percent of the flights were business or investment related, the aircraft was not "held for productive use in a trade or business or investment" as required for non-recognition treatment under Section 1031. A disputed the field's percentages and the field's treatment of the aircraft as not held for productive use in a trade or business or investment.

Law and analysis

Neither the Code nor the Income Tax Regulations under Section 1031 offer guidance concerning the phrase "held for productive use in a trade or business or for investment" (the "held-for" requirement). Nor did the Counsel Office find any case law dealing with whether to treat an asset as two properties for purposes of the 'held-for' requirement.

The Counsel Office noted that a plain reading of Section 1031 indicates that property either meets the "held-for" requirement or it does not. There is no support for the position that one relinquished property is treated as two properties for purposes of Section 1031. Further, the Service had an opportunity in Revenue Procedure 2008-16, 2008-10 I.R.B. 547, to treat one property as two for purposes of determining whether Section 1031 applies when that property is exchanged and did not do so. Revenue Procedure 2008-16 states that the Service will not challenge whether a dwelling unit qualifies as property meeting the "held-for" requirement even though the property is occasionally used for personal purposes if the safe harbor provisions are met. The Counsel Office remarked that, if property used for business/investment and personal purposes is treated as two properties for purposes of Section 1031, there would have been no need to publish Revenue Procedure 2008-16. Accordingly, the Counsel Office determined that the relinquished aircraft should be treated as one property that either meets the "held-for" requirement of Section 1031(a)(1) or does not.

In the instant case, the Counsel Office agreed that the high (redacted) percentage of personal use suggests that the property is not held for productive use in a trade or business or for investment. A thorough factual analysis should be conducted to make that determination. The Counsel Office suggested that the examiner consider: (1) business/investment use versus personal use based on flight hours, not just flights; (2) percentages of business/investment use versus personal for flights and flight hours for the year before the year of the exchange; and (3) which flights and flight hours were determined to be repositioning flights and the nature of the flight following the repositioning flight.

If the Field determines that over 50% of the use of the aircraft was for personal purposes, the memo concluded, then the aircraft was not held for productive use in a trade or business or for investment. Accordingly, the exchange would not qualify for like-kind exchange treatment under Section 1031.

Implications

When a taxpayer uses an aircraft both for business purposes and for personal use, the issue of how to treat the asset in a like-kind exchange (or for depreciation purposes) arises. In the depreciation context, the taxpayer is generally denied the depreciation related to the personal use of the property. In this CCA, however, the IRS provides a generally taxpayer-favorable ruling that the entire asset (or none of the asset) is treated as meeting the held-for requirement. Accordingly, the taxpayer may be able to apply Section 1031 to the entire gain/loss realized from the sale of the asset rather than deferring the business use gain and possibly losing the personal loss associated with the sale if the asset were bifurcated. The CCA provides welcomed rationale to an area without definitive guidance.