The Obama administration is looking into ending a tax break that has been heavily exploited by buyers and sellers of art. Referred to as a like-kind or 1031 exchange, for the section of the United States Internal Revenue Code section in which it appears, it enables investors in assets like real estate, art, and other collectibles to put off paying state and federal gains taxes on income from the sale of a property by immediately reinvesting it in a similar asset.
So, for instance, a collector who made $10 million on the sale of a Georgia O’Keeffe painting would normally owe $2.8 million of that gain to the government. However, by reinvesting those $10 million in a Cy Twombly painting (within the 180-day window for like-kind exchanges), the collector would defer paying any taxes on the gains from the sale of the O’Keeffe. The exchanges and deferrals can be compounded across multiple sales — our hypothetical collector could continue to avoid paying taxes on the gains from the O’Keeffe by immediately using funds from the sale of the Twombly to buy a Jasper Johns. (Interestingly, the law is considered to be medium-specific, and would not apply if gains from the sale of an O’Keeffe painting were used to buy an Alberto Giacometti sculpture.) Collectors may avoid paying capital gains taxes on sales of art entirely by keeping the works bought with the proceeds from an earlier sale until they die, or donating them to museums.
As the New York Times reports, the Obama administration’s revision of the law in its proposed budget for the fiscal year 2016 would limit the amount of capital gains from the sale of real estate on which tax payments could be deferred to $1 million and do away completely with the tax break for sales of art and other collectibles. The administration estimates that this change to the revenue code could bring in a total of $19.5 billion over the next decade in taxes that would otherwise be deferred or avoided.
“What we are seeing is yet another sophisticated federal tax avoidance scheme,” Ron Wyden, the Senator from Oregon and the Senate Finance Committee’s top-ranking Democrat, told the Times. “Some people are exploiting this tax provision as an estate planning tool to help them transfer wealth.”
There are no specific numbers for the taxes that art collectors avoid paying through the like-kind exchange scheme, but Suzanne Goldstein Baker, a lawyer for Investment Property Exchange Services and former president of the Federation of Exchange Accommodators (FEA), told the Times she handles exchanges involving hundreds of artworks every year. According to a study by Ernst & Young commissioned by the FEA, repealing the 1031 exchange law would result in an $8.1-billion drop in US gross domestic product (GDP) and “is at cross-purposes with some of the objectives of tax reform.”
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