The 1031 Exchange in Relation to Vehicles

It is widely known that 1031 exchanges apply to different property types, such as office to multifamily or even raw land to oil wells. However there is usually some uncertainty about using a 1031 exchange in the case of vehicles, such as airplanes or boats. The rule of thumb in these circumstances is that 1031 exchanges are acceptable but only within the same asset class. You can trade an airplane for another airplane but not for a boat.

The reasons for exchanging vehicles are slightly less intuitive than those for exchanging real estate assets. The usual purpose behind the 1031 exchange is to defer the tax you incur on appreciation in value in the underlying real estate. Vehicles represent another story, as they rarely appreciate in value. Instead, 1031 exchanges are primarily used with regard to vehicles in order to avoid “depreciation recapture”.

In order to illustrate this point with more clarity, here is an example:

Three smaller trainer Cessna aircrafts from the 1980s were exchanged for a new Cessna. When you buy a plane for 500k, you depreciate it over 5 years to offset its business income. When you get to year 6 your adjusted basis is zero so if you sell you trigger “depreciation recapture” a tax on your 5 years of depreciation. If you buy a plane of equal or greater to 500k, you will defer these gains. Most people “trade up” to get new basis by the amount of the trade up. So in my example you can buy a 650k plane and have 150k “fresh basis”.

So here we can see how the 1031 exchange can be of great value to those who own fully depreciated vehicles. This is an important point to remember, as it is often is forgotten, costing many to waste valuable resources on unnecessary taxes.

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