Friday, October 12, 2007

"Trade Your Picasso for a Degas - And Pay No Tax"

That's the headline of a piece that ran in yesterday's New York Law Journal [$] about "like-kind exchanges" under Section 1031 of the Internal Revenue Code. It began: "Can I really sell or trade my art and pay no tax? Well, Yes! You can sell your precious artwork now and later exchange it for another artwork without paying capital gain taxes on the sale."

Well, maybe. This is a really complicated question, but let me just say that it's not nearly so clear that Section 1031 applies to exchanges of art. I'll mention just two issues. First, the statute limits such exchanges to property held for productive use in a trade or business or for investment. It's not at all clear that the typical collector holds his artwork as an "investor." (Section 1031 does not define the term.)

Second, to qualify under Section 1031, the work must be exchanged for "like-kind" property. It's unclear how that applies in the art context. The IRS has ruled, for purposes of a different section of the Code (Section 1033), that lithographs were not "similar or related in service or use" to artworks in other media. Would the same result apply under Section 1031? Can an Abstract Expressonist painting be exchanged for an Old Master painting? Is that more "like-kind" than a contemporary painting and a contemporary drawing? No one really knows for sure.

So it seems to me that, in many cases at least, a collector will have a pretty heavy burden of showing (a) that he holds the artwork as an investment and (b) that he's exchanging it for like-kind work. There are also a number of technical requirements that have to be met, including filing IRS Form 8824 disclosing the transaction. On top of all that, the Treasury Department just a few weeks ago issued a report urging more scrutiny of 1031 exchanges generally ("In the wake of the Treasury report, 'I think you can expect increased IRS enforcement and oversight activity,' said Louis Weller, national director of real-estate transaction planning for Deloitte Tax LLP in San Francisco. IRS officials are 'aware of a lot of pushing-the-envelope activity by taxpayers.'").