2013 Tax Rate Changes Make 1031 Like-Kind Exchanges An Attractive Option For Art Investors

Two Congressional Acts, the 2010 Health Care Reconciliation Act and the American Taxpayer Relief Act of 2012, will affect tax rates in 2013. Art collectors will be subject to a 3.8% tax rate increase on the gain from the sale of art. Therefore, structuring a sale of art to qualify as an Internal Revenue Code Section 1031 Like-Kind Exchange may be an attractive option for art investors who wish to defer gain recognition.

Taxation of gain from the sale of art in 2013

Beginning in 2013, the 2010 Health Care Reconciliation Act imposes a 3.8% tax on certain investment income, as set forth in Internal Revenue Code Section 1411. This surtax for individuals is 3.8% of the lesser of (1) net investment income or (2) the excess of modified adjusted gross income over the threshold amount. The threshold amount is US$250,000 for a married couple filing jointly, US$125,000 for a married individual filing separately and US$200,000 for all other individuals. Among other things, the definition of 'net investment income' includes the net gain from disposition of property (other than property held in a trade or business). Therefore, this surtax will apply to gain from the sale of art.

The American Taxpayer Relief Act of 2012 does not change the tax rate of gain from art sales. The capital gains rate for collectibles, including art, as set forth in Internal Revenue Code Section 1(h), will remain at 28% for 2013. Therefore, in 2013, gain from the sale of art will be taxed at a combined federal rate of 31.8%.

1031 Like-Kind Exchange tax saving strategy

Internal Revenue Code Section 1031 provides for the non-recognition of gain or loss if certain qualifying property is exchanged solely for 'like-kind' property. Therefore, if an art collector is considering selling art and purchasing art, he or she may consider structuring the sale and purchase as one exchange transaction to avoid gain recognition on the sale that would otherwise occur if the sale and purchase are treated as two separate transactions.

However, the Internal Revenue Service has strict requirements that must be met in order for a transaction to qualify as a non-recognition, like-kind exchange. If an art collector decides to engage in a 1031 Like-Kind Exchange transaction, it is worth noting the following requirements.

The collector must hold...