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176. Does an Installment Sale Defer the Tax on Recapture of Accelerated Depreciation? No. Can the Tax on Recapture of Accelerated Depreciation Nevertheless Be Deferred When an Installment Sale Occurs? Yes.
162. Transfer a Family Business to the Next Generation During the Parent's Lifetime, Retain an Asset for Income, Give the Transferee a Stepped-up Basis, Defer the Gain on Sale, Support the Parent with Deductible Rent, and Finance the Transaction, Too
November 17, 2011
An industrial company has a fleet of aircraft, each of which is owned through a separate subsidiary. Every other year, the oldest airplane is sold, and a new one is acquired. The selling price is usually substantially greater than the depreciated tax basis of the aircraft.
We’ve been asked: When an aircraft is sold, is there a way to avoid the tax on depreciation recapture, or if not to avoid the tax, then to defer it?
The hurdle is Section 1245 of the Internal Revenue Code, which states the general rule that depreciation recapture on the sale of personal property or equipment is taxed as ordinary income. The taxable gain is the excess of "the lower of" (1) the "recomputed basis", (2) the "amount realized" on the sale, or (3) the property’s "fair market value" over (4) the property’s adjusted basis. The section goes on to say that "(s)uch gain shall be recognized notwithstanding any other provision of this subtitle"—which means that deferral of recognition of gain under Section 453 (the installment-reporting section) is not available.
According to Section 1245, the "recomputed basis" is calculated by adding back to the adjusted basis any depreciation deductions that were taken or that could have been taken.
So, since deferral of the tax is not available, the remaining choice is to avoid the tax, by having the "amount realized" on the sale be the same as the property’s adjusted basis.
Well, duh, you might say: Of course one could avoid the tax, by selling the property at book value, but who would do that, if the aircraft is worth substantially more?
Indeed, but remember that I said that each of the aircraft is owned by a separate entity. Therein lies an answer.
S.Crow Collateral Corp. can buy the aircraft at book value, for cash, and re-sell it at its market value. Later, in a tax-deferred, all-capital-gain transaction, S.Crow Collateral Corp. can buy 79% of the entity itself on an installment contract, at essentially the market value of 79% of the entity that the entity had while it owned the aircraft. We can buy the other 21% more than 12 months later, also on a tax-deferred installment contract. In the meantime, a separate lender is willing, when the aircraft is sold, to lend to the selling owner of the entity an amount of money that is nearly equal to the value of the aircraft that is sold. Our installment contracts assuredly fund the repayment of the loan.
Results: (1) The aircraft are sold at no taxable gain to the entity, either as ordinary income or as capital gain; (2) the owner of the entity sells the entity in tax-deferred, all-capital-gain transactions; (3) on day 1, the owner of the entity receives non-taxable loan proceeds in lieu of taxable sale proceeds; (4) the installment contracts assuredly fund the loan’s repayment; and (5) for reasons and in ways not explained here, the limitations in Section 453A are not a problem.
Careful planning of the ownership and transactional structures is required; one cannot wing it, and this is not for the haphazard or flighty.—Stan Crow
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The Latest Installment addresses situations, questions and issues which are brought to us in the course of the consideration, negotiation or execution of transactions. We don't use the real names of parties to transactions, and we may edit the statement of the question to try to tell the story better. Please feel free to comment, or to take issue, or to raise your own question or situation. If you do the latter, please do not relate any confidential information.
The Latest Installment blog is edited by Stanley D. Crow, who is president of S.Crow Collateral Corp.