In Chief Counsel Advice 201605017 the IRS National Office looks at how property used both for business and personal purposes is to be treated with regard to a like kind exchange under IRC §1031.
The rules provided in IRC §1031 provide that no gain or loss is to be recognized when certain property is exchanged for property that is of a like kind. However, for this provision to apply, the property must either be held for:
- Productive use in a trade or business or
- Investment. [IRC §1031(a)]
But what happens if the property in question is both held for a qualified use and also used personally by the taxpayer?
In the situation that gave rise to the memorandum the taxpayer had an aircraft that was both used for the taxpayer’s business and for personal purposes. The taxpayer exchanged the aircraft for a replacement aircraft and deferred recognition of gain under §1031.
One theoretical answer to the question would be to treat the property as two separate properties—the business portion which would qualify for §1031 treatment and the personal portion that would not. But the National Office concludes this treatment is not appropriate.
The memorandum begins by analyzing the language of §1031(a) itself and concludes this is an “all or nothing” test. As the memorandum notes:
The plain language of § 1031 suggests that property either meets the “held for” requirement or it does not. Under § 1031(a), “[n]o gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment” if the requirements of that section are met. If property used for business and personal purposes was to be treated as two properties, then gain or loss would be recognized on an exchange of that property contrary to the language in § 1031(a). Section 1031(b) deals with situations in which other, non-like kind property is received in an exchange but provides no support for the position that one relinquished property is treated as two properties for purposes of § 1031(a) if the property is both used in a trade or business and also used for personal purposes.
The memo goes on to note that the IRS’s safe harbor ruling on like kind exchanges of “partial vacation home” properties (Revenue Ruling 2008-16) does not take this approach.
If property used for business/investment and personal purposes is treated as two properties for purposes of § 1031, there would have been no need to publish Rev. Proc. 2008-16. Rather, the Service would require a deferral of the gain or loss allocable to the portion of the property that meets the “held for” requirement of § 1031 and require recognition of the gain allocable to the portion of the property used for personal purposes. Instead, the Service treats the entire property as held for productive use in a trade or business or for investment if the provisions of the revenue procedure are met.
But, the memorandum continues, having found this is an all or nothing test, the fact that the taxpayer used the property personally is a factor—the key question is whether the taxpayer’s intent is/was to use the property for trade or business or investment purposes. If it was, then the entire transaction falls under the §1031 rules. If not, none of the transaction is treated under those rules.
Unfortunately for those who like “bright line” tests, the memorandum concludes no such test or safe harbor exists here. As the memo continues:
Thus, the inquiry into whether property is “held for productive use in a trade or business or for investment” is intensely factual—doubly so when the property may naturally be used for both business and personal purposes. Unfortunately, § 1031 does not provide for a simple quantitative use formula. In other words, there are no authorized absolute mechanical or quantitative tests for measuring intent and no safe harbor rules have been promulgated for these circumstances. Rather, intent must be determined by the unique facts and circumstances extant in each given transaction.
In this case the memorandum notes that the percentage of personal use is a key factor and, despite the above analysis, concludes a 50% use test is an appropriate way to judge the intended use. As the analysis continues:
While we agree that the X percent figure cited by the field suggests that the property is not held for productive use in a trade or business or for investment, additional facts should be considered in determining whether the “held for” requirement of § 1031(a) is met. For example, we suggest that the examiner consider: (1) measurement of 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. Assuming you determine that over 50 percent of the use of the aircraft was for personal purposes, we agree with your position that the aircraft was not held for productive use in a trade or business of for investment