{"id":426,"date":"2012-10-01T09:51:27","date_gmt":"2012-10-01T16:51:27","guid":{"rendered":"http:\/\/www.danziger.com\/articlesnews\/?p=426"},"modified":"2012-10-01T09:51:27","modified_gmt":"2012-10-01T16:51:27","slug":"apples-and-picassos","status":"publish","type":"post","link":"https:\/\/danziger.com\/?p=426","title":{"rendered":"Apples and Picassos"},"content":{"rendered":"

“Like-kind” art trades may bring tax benefits, but only if carefully executed.<\/strong><\/em><\/p>\n

OUR NEW CLIENT Joe was a Wall Street trader and avid collector
\nof works on paper. Although not all his trades panned out”
\n(Iceland didn\u2019t want any submarines because it has no navy),
\nJoe\u2019s tax bill was still high. When he came to us, he reckoned he
\nhad found the perfect solution: \u201clike-kind exchanges\u201d of his
\nart under Section 1031 of the Internal Revenue Code, which
\nhe thought would permit him to defer taxes indefinitely while
\nallowing him to trade his works for other assets. Although
\nwe see many proposed like-kind exchange transactions, those
\nthat are done correctly in the art world are about as rare as
\nIcelandic admirals\u2014and so it was with trader Joe\u2019s.<\/p>\n

His first brainstorm was to swap some Warhol lithographs
\nhe had inherited for a two-bedroom condo in New York\u2019s
\nTribeca neighborhood. The art and real estate were both
\nworth about $2 million, so he presumed the exchange would
\nhave no tax consequences.<\/p>\n


\nNot so, we replied, and gave him a quick 1031 primer.
\nArt transactions that qualify under Section 1031 allow for
\ntax deferral\u2014not tax elimination\u2014on capital gains from the
\nsale of qualified works if the proceeds are reinvested in like-kind
\nworks within a certain statutory period. The rationale is
\nthat one work has merely been swapped for another substantially
\nsimilar property, and so taxes should be paid not on the
\nswap but on the eventual sale of the replacement work.<\/p>\n

However, in order to qualify for 1031 treatment, Joe faced
\nsome serious hurdles. First, he would have to prove that he
\nacquired the art primarily for investment, and not just for
\npersonal use and enjoyment.<\/p>\n

The problem for Joe was that he hadn\u2019t bought the Warhols but had inherited them, and
\nfor years they had been decorating his East Hampton house.
\nTo us, the prints seemed to be part of his personal collection,
\nnot acquired and held primarily for investment.<\/p>\n

Second, and just as important, Section 1031 speaks of
\nexchanged property that is like-kind in \u201cnature or character.\u201d
\nSwapping art for real estate would clearly not qualify
\nfor 1031 treatment. End of story.<\/p>\n

\u201cOK, so how about I swap a small Serrano photo for a
\n17th-century ceramic saucer?\u201d suggested Joe.<\/p>\n

Not so fast, we warned him. Neither the IRS nor court
\ndecisions clearly define a like-kind standard for art. On
\nthe one hand, art in different media should qualify for the
\nexchange since their nature and character as works of art
\nremain the same. Moreover, since differences in \u201cgrade or
\nquality\u201d do not matter under Section 1031, variations in
\nartist, medium, style, and value can be viewed as irrelevant
\nto whether the art qualifies.<\/p>\n

On the other hand, in a private-letter ruling issued by the
\nIRS in 1981 involving a taxpayer who owned a portfolio of
\nartworks destroyed in a fire, the IRS held that lithographs
\nmay not be replaced with art in other media. However, that
\nruling was under a different section of the tax code\u2014Section
\n1033. Moreover, private-letter rulings (unlike revenue rulings)
\nare only for the use of the taxpayers to whom they are issued
\nand may not be relied on by others. Since the standard under
\nSection 1033 for casualty losses is more restrictive than the
\n\u201clike-kind standard\u201d under Section 1031, requiring that the
\nreplacement property be \u201csimilar or related in service or use\u201d to
\nthe property destroyed, we questioned whether the same result
\nwould apply under Section 1031.
\nIn fact, courts have gone so far as to say that
\neven different impressions of the same print may not be considered fully
\nequivalent. In the 1993 case David Tunick, Inc. v. Kornfeld, a New
\nYork federal district court held that because fine art prints are unique,
\nthe buyer of an authentic print with an allegedly forged signature does
\nnot have to accept a replacement print with an authentic signature.
\nThe court observed that \u201ctwo prints from a series…possess distinctive
\nqualities that may impact their aesthetic and economic value\u201d
\nbased on the wear of the plate during printing. The case involved a 1935
\nPicasso print, La minotauromachie, which dealer David Tunick bought
\nfrom Swiss auctioneer Eberhard Kornfeld and Galerie Kornfeld und
\nCie for $1.68 million. The parties settled out of court in 1994.<\/p>\n

Although the Tunick case does not pertain directly to Section 1031
\ndefinitions of like-kind property, it does illustrate that constructing
\na valid exchange is trickier than Joe (and others) may believe.<\/p>\n

We also pointed out that various technical requirements make 1031
\nexchanges even more complicated. For instance, if the taxpayer were
\nhimself or through an agent to receive the proceeds of the sale of a relinquished
\nwork before a replacement work is acquired, the IRS would
\nnot allow the 1031 transaction. That is why taxpayers making 1031
\nexchanges use not only experienced attorneys (we hope) and accountants
\nbut also middlemen, called qualified intermediaries (QIs), who hold
\nproceeds from the sale of the exchange property and pay these proceeds
\nto the seller of the replacement property. The QI must be an independent
\nparty, which is why we can\u2019t act as the QI for our clients. Generally, the
\ntaxpayer must identify the replacement property within 45 days and
\nacquire it within 180 days of the date on which the relinquished property
\nis transferred; otherwise, the IRS will disallow the transaction. In addition,
\ntaxpayers must file an IRS Form 8824 disclosing the transaction.<\/p>\n

Joe was undaunted. \u201cHere\u2019s another trade,\u201d he continued. \u201cI want to
\nreplace one Basquiat drawing with another, but since his drawings sell
\nquickly and inventory is scarce, could I buy the new one before selling
\nthe old one and still defer tax?\u201d<\/p>\n

The answer is yes. In 2000, the IRS issued Revenue Procedure 2000-
\n37, which created a safe harbor for a \u201creverse 1031 exchange\u201d when
\nreplacement property is purchased prior to closing on the relinquished
\nproperty. In a reverse exchange, a separate holding company, referred to
\nas an exchange accommodation titleholder (EAT), is established to take
\ntitle to (or \u201cpark\u201d) either the relinquished property or the replacement
\nproperty. A parking arrangement is necessary for a reverse exchange
\nbecause the IRS does not allow the exchanger to have title to both the
\nrelinquished property and the replacement property at the same time.<\/p>\n

\u201cEAT? Park?\u201d asked Joe. \u201cI eat steaks and park my Porsche, but
\ntechnical legal requirements give me gas. What\u2019s the worst that could
\nhappen if I just ignored the rules?\u201d<\/p>\n

\u201cJail time,\u201d we replied cheerfully. After all, on the other side of
\nthe table will be the IRS, not some kid on a trading desk in Delhi. We
\nreminded Joe that the Pop artist Peter Max was indicted in 1996 by a
\nFederal grand jury on charges that he bartered his paintings as part
\npayment for homes in Woodstock and Southampton, New York, and
\nin the U.S. Virgin Islands while failing to declare the \u201csale\u201d of those
\npaintings on his income tax returns. Max reportedly pleaded guilty
\nto charges of conspiracy to defraud the IRS and tax evasion and was
\nsentenced to two months in prison and a $30,000 fine.<\/p>\n

\u201cMany of my closest colleagues went to jail,\u201d shrugged Joe.
\nJoe ended our meeting by asking about yet another trade: Could he
\nbarter our legal fees for his signed first edition of Liar\u2019s Poker?<\/p>\n

We politely declined, saying that we had read the book years ago and
\nhad even gotten a copy for our mother.<\/p>\n

\u201cGood trade,\u201d he smirked. Download this article here.<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

OUR NEW CLIENT Joe was a Wall Street trader and avid collector
\nof works on paper. Although not all his trades panned out”
\n(Iceland didn\u2019t want any submarines because it has no navy),
\nJoe\u2019s tax bill was still high. When he came to us, he reckoned he
\nhad found the perfect solution: \u201clike-kind exchanges\u201d of his
\nart under Section 1031 of the Internal Revenue Code, which
\nhe thought would permit him to defer taxes indefinitely while
\nallowing him to trade his works for other assets. Although
\nwe see many proposed like-kind exchange transactions, those
\nthat are done correctly in the art world are about as rare as
\nIcelandic admirals\u2014and so it was with trader Joe\u2019s.
\nHis first brainstorm was to swap some Warhol lithographs
\nhe had inherited for a two-bedroom condo in New York\u2019s
\nTribeca neighborhood. The art and real estate were both
\nworth about $2 million, so he presumed the exchange would
\nhave no tax consequences.<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"class_list":["post-426","post","type-post","status-publish","format-standard","hentry","category-articles"],"_links":{"self":[{"href":"https:\/\/danziger.com\/index.php?rest_route=\/wp\/v2\/posts\/426","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/danziger.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/danziger.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/danziger.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/danziger.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=426"}],"version-history":[{"count":0,"href":"https:\/\/danziger.com\/index.php?rest_route=\/wp\/v2\/posts\/426\/revisions"}],"wp:attachment":[{"href":"https:\/\/danziger.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=426"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/danziger.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=426"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/danziger.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=426"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}