Exchange Facilitator Does Not Beat Missouri Use Tax On Learjet

This post was originally published on Forbes Jun 15, 2015

The Like-kind exchange is a powerful tax deferral tool.  The Code Section that supports it - 1031 - is one of the few Code sections, like 501(c)(3) and 401(k), that have worked their way into the vocabulary of people other than tax geeks. Although the like-kind exchange is used heavily in real estate, there are other applications since 1031 applies to most property used in a trade or business or held for the production of income.  One example is corporate jets.  Even if they don't appreciate, they hold their value a lot better than the cost recovery deductions that are allowed would indicate so selling one jet to buy a new one can cause significant ordinary gain recognition.

So the like-kind exchange can be great for income tax deferral. But what about sales and use tax?  That's why KCC Contractor Inc and John Q. Hammons Industries were before the Administrative Hearing Commission of the State of Missouri.  What they learned was that a transaction that qualifies for tax deferral under federal tax principles does not necessarily avoid sales and use tax.

Missouri law does provide for an exclusion from sales and use tax on trade-in allowance

 Notwithstanding any other provisions of law to the contrary, in any retail sale... where any article on which sales or use tax has been paid, credited, or otherwise satisfied or which was exempted or excluded from sales or use tax is taken in trade as a credit or part payment on the purchase price of the article being sold, the tax imposed by sections 144.020 and 144.440 shall be computed only on that portion of the purchase price which exceeds the actual allowance made for the article traded in or exchanged, if there is a bill of sale or other record showing the actual allowance made for the article traded in or exchanged

KCC and JOH were hoping to take advantage of that rule as they had traded in their $9.1 million 2004 Learjet on the purchase of a $10.6 million 2007 Learjet - kind of.  Here is the thing.  Federal income tax law allows exchanges to be done through "qualified intermediaries".  You don't actually sign your relinquished property over to the seller of your target property, like you or I would do at the car dealership.  You sign it over to the exchange facilitator who sells it to some third party.  The facilitator then applies the cash from the sale to buy your target property from a fourth party.

Exchange facilitation is something of a mini-industry within each industry in which 1031 has broad practical application.  KCC and JOH used Virginia Air Exchange Inc. to execute the transactions.

Citing earlier cases with similar fact patterns, the Commission ruled that the federal income tax facilitation rules do not operate to reduce sales and use tax.

The word “trade” means “to give in exchange for another commodity.” The word “exchange” means “the act of giving or taking one thing in return for another,” or “the process of reciprocal transfer of ownership (as between persons).” A “trade,” then, requires that the parties each have title to or ownership of their respective items and then exchange them. 

The Court describes the exemption created by § 144.025.1 as the “taken in trade” exemption. From there, it analyzed the transaction between the taxpayer and the other participants in it and concluded that the aircraft the taxpayer bought was not “taken in trade” for purposes of the statute because there was no exchange of aircraft, and therefore there was no trade.

So even though, the companies may have gotten the income tax deferral that 1031 is designed to yield the benefit did not extend to use tax.  Presumably, it would have worked if Learjet had taken the 2004 model in trade for the 2007 model, but there are probably business reasons why that was not an option.

The important lesson here is that concepts that work in federal income taxation do not alway translate well when applied in the SALT  (State and local tax) area .