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| 1031 ADVISOR February 2009 |
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Impact of Sales Tax on Business Asset Exchanges, Including Aircraft Most practitioners are aware that income taxes on a Section 1031 Exchange of business assets can be deferred. However, in the arcane world of sales and use taxes, the states generally seek to impose sales taxes in full on the purchase and sale of (taxable) business assets rather than permitting a credit for the prior tax paid on the replacement property. In the case of aircraft exchanges, these transactions are highly visible because they are reported to the states by the Federal Aviation Administration. Given the stark shortfall in tax collections, we have seen a marked increase in sales and use tax collection activity throughout the Midwest. In a recent Missouri case, Great Southern Bank vs. Director of Revenue, S.C. 88943 (Mo., Nov. 4, 2008), a taxpayer entered into a Section 1031 Exchange with a Bank Intermediary involving aircraft. The Missouri Supreme Court held that the exchange was not a single transaction between the bank and the taxpayer in which the taxpayer received trade-in credit for the relinquished aircraft. Rather, the Court bifurcated the like-kind exchange, holding that the bank was acting as the taxpayer’s agent for the purpose of two separate transactions—a sale of the relinquished aircraft, and a purchase of the replacement aircraft. Thus, no trade-in of the relinquished aircraft occurred. As a result, use tax was due on the full value of the replacement aircraft. The state did not credit sales and use tax previously paid on the relinquished property that was taken in trade for other property. Similarly, in Hutton vs. Johnson, 956 S.W.2d 484 (Tenn. 1997), another like-kind aircraft exchange was bifurcated into two separate transactions, subjecting the full price of the replacement aircraft received by a taxpayer to use tax. In that transaction, the taxpayer entered into an Exchange Agreement with a buyer, which purchased the relinquished aircraft from the taxpayer and acted as a qualified intermediary for purposes of Section 1031. The Supreme Court of Tennessee held that the full purchase price of the replacement aircraft was subject to use tax. The Court stated that the series of events was two separate transactions—again, a sale and a purchase. The Court stated that the series should not be viewed as one integrated transaction for the following reasons:
Both instances highlight the importance of proper structuring of a Section 1031 Exchange transaction in order to avoid bifurcation of the transaction and the application of sales or use tax. While most property is not as visible as aircraft, potential sales and use tax assessments on property received in a Section 1031 Exchange remains an audit risk for everyone handling business asset exchanges. Thorough state tax planning may prevent the additional cost tax on these transactions. Many thanks to our friends Michael A. Grim and Laura C. Harbison of Greenbaum Doll and McDonald for contributing this article to our February 1031 Advisor Newsletter.
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