“Art is an investment” is a cliché for good reason. Because for some collectors, that Mark Rothko piece hanging above your desk is the creative equivalent of 10,000 shares of Apple stock purchased at the $6 mark. Just as other commodities are bought and sold, so too is art. When it comes to capital gains, the IRS sees no difference between the two. Unless you plan ahead!
Section 1031 of the Internal Revenue Code states that, “Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange.”
Investment property? Gain? Like-kind exchange?
“The simplest way to explain Section 1031,” says Citibank senior vice president David Gorenberg, “is to simply say that it’s like playing Monopoly with real properties and real money, and not paying taxes when you sell Pennsylvania Avenue to buy Boardwalk.
“To make it simple in the art realm: I have one artist hanging on the wall of my office today. I’m redecorating and that art no longer fits with the décor, so I’m going to sell it. It’s worth more than when I bought it, so that is a taxable event. If I do a 1031 exchange, not only can I roll the proceeds of the sale into the new art, but I can not pay the taxes and use all of the proceeds as opposed to the sale price minus capital gains tax.”
Complicated? Sure. Which is where the Citibank 1031 Exchange team comes in, and as early on in the process as possible. “They cannot hire us after they’ve sold the first piece, because the IRS regulation requires that we be involved before they touch cash,” says Gorenberg.
It’s also important to note that Section 1031 was established—and only applies to—business properties and investments. Which means that Picasso hanging in your beach house won’t cut it. “When you look at the vast majority of these transactions, they tend to be real estate-focused,” says Gorenberg. “Then a huge portion of what’s left is machinery, equipment and vehicles. It’s pretty easy to understand that you bought that pickup truck to haul lumber; when you’re talking about artwork, you’re not using the artwork as an asset in your trade or business per se, other than it’s decorating your conference room.
“We have to show that the art was held as an investment,” continues Gorenberg. “So simply hanging it on your living room wall does not necessarily make it an investment… But if it’s on the wall in your office, it’s clearly a business asset.”
The ability to prove these distinctions, should usage come into question, is yet another reason not to attempt to tread the Section 1031 waters alone.
“The two main things to keep in mind are that you can’t touch the cash proceeds of the sale along the way, so a neutral third party has to hold the cash,” says Gorenberg. “That’s where the role of the qualified intermediary comes in and that’s what we do. You also have timing restrictions within which you must complete the transaction. So if you sell your Rothko today, you have 45 days to identify what it is you’re going to be buying and provide a short list—typically up to three pieces—and you must complete that acquisition within 180 days.” At which point the taxpayer can defer up to 100 percent of the capital gains and depreciation capture that would normally be calculated at the time of the sale.
Concludes Gorenberg: “Because the transaction numbers are smaller in art than they are in real estate and other assets, so is the guidance from the IRS. So if you’re contemplating a 1031 Exchange, you should speak to your tax and legal advisors and should contact a qualified intermediary as early on in the discussion as possible.”
To learn more about Citibank’s 1031 Exchange Services, call (855) 253-1031, visit www.citibank.com or meet the team at Artexpo New York, beginning March 22nd.