Some individuals and businesses acquire artwork or collectibles as investments or for use in their trade or business. Recently, many artworks and collectibles have realized significant appreciation in value. When appreciated artwork and collectibles are sold, the owner is subject to capital gains taxes. Even with the current low capital gains rates the tax liability on highly appreciated assets can be substantial.

Under Section 1031 of the Internal Revenue Code ("IRC §1031") individuals and businesses may exchange qualifying property for like-kind replacement property. In qualifying transactions, the taxpayer defers recognition of up to 100% of the capital gains and depreciation recapture that would otherwise occur at the sale of the property. This transaction structure is known as a "like-kind exchange." Collectors of artwork or other collectibles who plan to sell an asset and acquire another one shortly thereafter should discuss IRC §1031 with their tax and legal advisors, and consider structuring the transaction as a like-kind exchange. The tax savings enable the reinvestment of more money into the replacement property.

The "Like-Kind" Requirement

There is very little guidance on like kind rules for artwork, collectibles, and other types of non-depreciable personal property. In 1981, the IRS issued a Private Letter Ruling (PLR 81-27089) that provides some guidance. The taxpayer owned a portfolio of artwork that destroyed in a fire. The destroyed portfolio contained 99% lithographs and 1% other artwork. The replacement portfolio contained 63% lithographs and 37% other artwork. The IRS held that the artwork in one medium was not similar or related in service or use to the artwork in another medium. However, the standard under §1033 for casualty losses is more restrictive than the "like-kind standard" under §1031. Therefore, a taxpayer might feel comfortable that the taxpayer can satisfy the like-kind requirement for works of art within the same medium, irrespective of artists or period of the work.

Collectors considering an exchange or artwork or collectibles should consult an art expert and a knowledgeable tax professional to determine whether the relevant pieces are like-kind (i.e. of the same "nature or character").

In treating like-kind issues for other types of non-depreciable personal property, the IRS has determined:

  • A copyright in a novel is not like kind to a copyright in a song.
  • A copyright in a novel is like-kind to a copyright in another novel.
  • Gold bullion is not like-kind to silver bullion.
  • Gold bullion is like-kind to gold bullion coins.
  • Gold bullion coins are not like-kind to collectible gold coins.

Collectors should consider disposing of artwork and collectibles in a deferred exchange whenever reasonably possible. The current federal capital gains tax rate on artwork and collectibles is ample incentive to defer taxes. Advance planning and coordination among the taxpayer, Qualified Intermediary (QI), and tax advisor are needed to ensure a successful exchange of artwork and collectibles.
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