Can You Do a 1031 Exchange on an Aircraft?

A 1031 exchange is a remarkably helpful tool for investors to manage their capital gains taxes. When you want to sell an investment property and reinvest the proceeds, using a 1031 exchange enables you to reinvest the entire proceeds while deferring payment of capital gains taxes. This simple tactic provides excellent leverage for investors.

For example, suppose you own a rental property you purchased ten years ago for $100,000. If that property is now worth $300,000, you would owe capital gains taxes on the $200,000 appreciation. If you are in a high tax bracket, the tax could be $40,000. Paying that much would significantly diminish what you have available for reinvestment.

If you employ a 1031 exchange to sell the targeted property and buy a replacement, you can defer the payment of the capital gains tax. But there are some rules to follow:

1. The replacement property (or properties) must have at least as much value as the property being relinquished.
2. If the property being sold has a mortgage, the investor must also match the debt level with the new asset purchase.
3. The properties must be “like-kind.” The IRS considers any investment property to be “like-kind” to another. For instance, you can replace a residential rental with a self-storage facility or a retail property with raw land.
4. The investor must complete the purchase of replacement property within 180 days of the sale of the relinquished property. Within those 180 days, another deadline is 45 days from the sale of the first asset. Within 45 days, replacement property options must be identified (identification is a formal process, and there are options for identifying prospects).

Taxpayers should keep in mind that the 1031 exchange provides a deferral, not an elimination, of the taxes due. If the investor later sells the replacement property without completing another 1031 exchange, they will then owe capital gains taxes on the current transaction as well as the taxes previously deferred. However, if the taxpayer holds the replacement property until they distribute their assets after their death, the heir will receive the distribution at the stepped-up basis.

Investors executing a 1031 exchange will need the guidance of a Qualified Intermediary who oversees the transactions, collects the appropriate documentation, and secures the sale proceeds in a separate account until they are required in order to pay for the replacement assets.

Can I do an exchange involving aircraft?

No. The rules around 1031 exchanges have been clarified over time to exclude any capital assets that are not investment property. As mentioned earlier, the IRS is generous in defining "like-kind" as it relates to property, but everything outside of that category is excluded. In the past, other assets could be exchanged using section 1031, but that is no longer possible. The Tax Cuts and Jobs Act of 2017 codified the exclusion of capital assets other than real property from 1031 exchange eligibility.

However, property that is used for airplane services is likely to be eligible if it is an investment. That use could include a private airfield, aircraft storage, servicing, and other related activities. Just as property that houses other businesses is eligible, the same would be true for property that supports aircraft business functions. As with other investment properties, the taxpayer can exchange this airfield asset for other investment property and defer the capital gains taxes.