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The President's Attack on Like-Kind Exchanges

The President's Attack on Like-Kind Exchanges

This year art is also under scrutiny 

The Fiscal Year 2016 Budget proposes a modification of like-kind exchange transactions.  As in the Fiscal Year 2015 Budget, the Administration proposes to limit the amount of capital gain deferred under Section 1031 of the Internal Revenue Code from the exchange of real property to $1,000,000 (indexed for inflation) per taxpayer per taxable year.  The Administration now also proposes that art and collectibles no longer be eligible for like-kind exchanges.  The proposal only applies to like-kind exchanges completed after Dec. 31, 2015.1  

How Like-Kind Exchanges Work Now

The current version of IRC Section 1031, which regulates like-kind exchange transactions, provides that in general "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment."2  There are no current limits on the value of the property.  However, limits on the types of property that can be used as part of a like-kind exchange already do exist.  A taxpayer can’t use stock in trade or other property held primarily for sale, stocks, bonds, notes, other securities, evidences of indebtedness or interest, interests in a partnership, certificates of trust or beneficial interests or choses in action as part of a like-kind exchange.3

Like-kind exchanges enable a "deferral" of capital gains tax, not an "avoidance" of tax.  If an individual purchases art for $100,000 and later sells the art for $150,000 in cash, the individual's $50,000 gain is recognized and subject to tax.  If, instead, the individual reinvests the $150,000 in other art, no gain is recognized on the exchange; therefore, no tax is due at that time.  If later, the individual sells the art for $250,000 in cash, gain is recognized on $150,000 (the sale proceeds minus the original cost basis of the first work of art exchanged).  The $150,000 will be taxed at the capital gains rate for collectibles in the year that the cash is received.  This rate may be the same, higher or lower than that in the year of the exchange, so the individual is taking a gamble when deferring.        

Proposal Decreases Buying Power of U.S. Art Investors

If passed, the proposed exclusion of art and collectibles from being used in like-kind exchange transactions would be yet another provision in the tax code that could discourage individuals from investing in art.  Gains from the sale of art and collectibles are currently taxed at a 28 percent federal rate, the highest federal tax rate for capital assets held for over a year.4  When factoring in other federal and state taxes that art sales may be subject to, an individual could face an over 40 percent tax on the sale of art.  If that individual had sold art for the purpose of reinvesting in other art, the individual would now have 40 percent less cash to reinvest in the art market.

This decrease in buying power could affect the United States' position in the global art market.  The United States is one of the few countries that taxes its citizens on their worldwide income, regardless of where it’s earned.  As such, U.S. citizens receive no income tax benefit from conducting art sales in "freeports" (customs zones in which taxes and fees are not charged by the country in which the zone is located) the way that citizens of other countries do.  For instance, if a Chinese citizen who’s residing outside of China sells art in a Swiss freeport, the gain from the sale would not be subject to tax because China, unlike the United States, doesn’t tax Chinese citizens on income earned outside of mainland China, and Switzerland doesn’t charge a tax on transactions conducted in its freeports.  The Chinese citizen would then have 100 percent of the sale proceeds at his disposal to reinvest in art.  The United States does tax U.S. citizens on sales that occur in freeports, so a like-kind exchange serves as an important mechanism to even the global art market's playing field.

The "Avoidance" Misconception

There’s a misconception that a like-kind exchange is a tax "avoidance" mechanism.  As explained above, it’s merely a "deferral" mechanism.  When an individual stops reinvesting in the art market and sells art for other property, which is what happens in most cases, tax will be owed.  If an individual dies owning art, then regardless of whether or not the art had been used as part of a like-kind exchange during the individual's life, the art (as well as other property in the estate) would receive a step-up in basis to fair market value for income tax purposes.  It would be a rare case for tax to be avoided completely, as the art in the estate may be subject to transfer taxes.   

Therefore, President Obama's statement in his Budget Message that the Fiscal Year 2016 Budget "closes loopholes that perpetuate inequality by allowing the top one percent of Americans to avoid paying any taxes on their accumulated wealth and uses that money to help more young people go to college" is not accurate with regard to the budget's proposal for modifying like-kind exchanges.5 The statement also begs the question, what’s the money that’s deferred from taxation being used for now?  By Section 1031's clear terms, the money must be used to reinvest in the art market, keeping cultural treasures in the hands of U.S. persons.

Market Benefit of the Tax Deferral

In accordance with the like-kind exchanges regulations, gain isn’t recognized only if the property being sold is exchanged with like-kind property.  Like-kind exchanges, thereby, encourage art investors to continue to purchase art, which supports the domestic art market. 

At least 39 million art sales occurred in 2014, with the three major art markets being the United States, the United Kingdom and China.  Sales in post-war and contemporary art, which dominate the global art market, are centered in the United States.  Additionally, the United States has the greatest share of art fairs in the world, attracting millions of visitors annually.  The growth of companies in the online art space has been a trend in the art market, and in 2014 the highest ranking art specific sites (, were being operated from the United States.6  This activity is in line with President Obama's "middle-class economics," which he defines as "creating the kind of environment that helps businesses start here, stay here, and hire here."7 The proposed modification of like-kind exchanges would undo the United States' standing and innovation in the art market; thus, undoing much of the increased revenues and resulting in art being moved overseas to the detriment of U.S. museums, which rely heavily on loans from U.S art investors for their public exhibitions.


1. Fiscal Year 2016 Analytical Perspectives of the U.S. Government, pg. 169.

2. Internal Revenue Code Section 1031(a)(1).

3. IRC Section 1031(a)(2).

4. IRC Section 1(h)(4).

5. Fiscal Year 2016 Budget of the U.S. Government, pg. 3.

6. "Global Art Sales in 2014 break all known records," The European Fine Art Foundation, March 9, 2015.

7. The Budget Message of the President for the Budget for Fiscal Year 2016, pg. 2.


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