To say that the art market, including public auctions and private sales, has performed very well in the last several years would be an understatement. The press has reported on the record breaking auction sale of Edvard Munch’s “The Scream” at Sotheby’s and on Christie’s historically successful sale of post-war and contemporary art last November, totaling approximately $412 million.1 These headlines have excited existing art investors and attracted many new ones. Individuals who’ve been collecting for several decades still have a hard time believing the number of zeros added to art prices these days. During the November 2012 auctions in New York, a Franz Kline work sold for nearly $40.4 million, which is more than quadruple his previous auction record of $9.3 million. However, this pleasant surprise for investors selling their art is often overshadowed by the number of zeros added to their tax bill after a profitable sale.  

With increasing art sale prices, art investors generating substantial amounts of gain have been seeking advice on how to best structure their sales. Prior to 2013, the tax rate on gains from the sale of art was 28 percent. In 2013, the additional 3.8 percent tax on investment income has made the search more urgent. As the May 2013 auction season in New York approaches, like-kind exchanges present an attractive option for art investors who wish to defer gain recognition. Art investors are thrilled to hear the tax benefits of a like-kind exchange, but they’re usually not as enthusiastic about the rules that must be followed.  


A Changing Landscape 

Two Congressional Acts, the 2010 Health Care Reconciliation Act (HCRA) and the American Taxpayer Relief Act of 2012 (ATRA), affect the federal taxation of art sales in 2013.  

Beginning in 2013, HCRA imposes a 3.8 percent tax on certain investment income.2 This surtax for individuals is 3.8 percent 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 $250,000 for a married couple filing jointly, $125,000 for a married individual filing separately and $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.

ATRA doesn’t change the tax rate of gain from art sales. The capital gains rate for collectibles, including art, will remain at 28 percent for 2013.3 Therefore, in 2013, gains from the sale of art will be taxed at a combined federal rate of up to 31.8 percent.


An Attractive Option

An art investor contemplating selling and purchasing art may consider structuring the sale and purchase as one exchange transaction. This will avoid gain recognition on the sale that would otherwise occur if the sale and purchase were treated as two separate transactions. Recognition of the gain that’s realized on the sale will be deferred, and the art that’s purchased will acquire a carryover basis from the art that’s sold.

Internal Revenue Code Section 1031 and the corresponding Treasury regulations provide guidelines for the non-recognition of gain or loss for certain qualifying property exchanged solely for “like-kind” property. No gain or loss will be recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of like-kind that will be held either for productive use in a trade or business or for investment.4 For a like-kind exchange, the taxpayer must sell property to and buy property from the same individual or entity. The Treasury regulations refer to this individual or entity as the investor’s “qualified intermediary” (also known as the “investor’s agent”).

The basic steps for an investor to execute a like-kind exchange are: (1) selecting a qualified intermediary; (2) identifying artworks to be sold to the qualified intermediary and entering into an exchange agreement; (3) transferring the identified artwork to the qualified intermediary for a subsequent sale to a third party; (4) identifying artwork within 45 days of Step (3) to be purchased by the qualified intermediary from the third party; (5) transferring the purchased artwork from the qualified intermediary to the investor within 180 days of Step (3); and (6) notifying the Internal Revenue Service of the transaction by filing Form 8824. 

If a like-kind exchange is executed properly, it can be a useful tool for art investors to defer gain recognition. However, when pitching the idea to a client who’s an art investor, there are key issues that are worth mentioning up front.


Common Client Questions

The IRC and Treasury regulations have strict requirements that must be met for a transaction to qualify as a like-kind exchange. Clients who are art investors engaging in like-kind exchange transactions often have these questions:  

Am I a collector or an investor? Your clients must consider whether they buy and sell art primarily for investment or for personal use and enjoyment. Gain deferral treatment for a Section 1031 like-kind exchange only applies to “investors” in art and not “collectors” of art. Unfortunately, no clear definition exists for either category, but the key question is whether the taxpayer is engaged in buying and selling art with the primary objective of making a profit. The Treasury regulations set forth nine factors to consider in determining whether an activity is engaged in “for profit.”5 The most relevant of these factors are the manner in which the taxpayer carries on the activity and the profits and elements of personal pleasure incurred from the activity.

Are these works of art “like-kind”? Clients frequently ask for guidance about the type of artwork they can identify as replacement property in a like-kind exchange. The IRS hasn’t provided much guidance regarding the requirements of how similar the replacement art and the relinquished art must be. Exchanges of artwork in the same medium will likely qualify as “like-kind.” However, whether exchanges of artwork in different media will qualify is more ambiguous. In a situation in which artworks were damaged in a fire and replaced with new artwork, the IRS ruled that oil paintings, watercolors and sculptures that were purchased to replace damaged lithographic prints weren’t similar property for purposes of gain deferral.6 For non-taxable exchanges caused by involuntary conversions under IRC Section 1033, the IRS wouldn’t consider artwork in one medium, destroyed in whole or in part, replaced with artwork in another medium, as property similar or related in service or use. The IRS may or may not apply the same standards to like-kind exchanges under Section 1031, but it’s unlikely that the IRS will issue further clarifications on this issue.

Art is art. Why does it matter if the art was used outside the United States? In addition to an art’s medium, the locations of the works of art being used in the like-kind exchange are important factors to consider. With regard to the use of like-kind property, the IRS has issued specific rules, and in a global art market in which the identity of the seller is usually confidential, these rules can be limiting. Artwork used predominantly within the United States and artwork that’s used predominantly outside the United States are generally not considered to be like-kind property.7 Predominant use of property is determined based on the two-year period ending on the date of relinquishment and the two-year period beginning on the date of the acquisition. The IRS clarified that the meaning of “use” is consistent with the common definition of use as the “legal enjoyment of property that consists of its employment, occupation, exercise or practice.”8 This poses a question as to which category art owned by an individual residing outside of the United States, who stores that art in a storage facility in the United States, belongs. It’s also questionable whether this use distinction is appropriately applied to art, a non-depreciable asset, considering that the reason for this distinction is that the depreciation rules applicable to foreign and domestic use are sufficiently dissimilar so as to treat such property as not “like-kind.”9 In the context of the global art market, if we rely on the literal reading of this rule, it should be carefully considered, as it could easily disqualify an exchange from non-recognition treatment.

The art market is competitive. Are there more options? With the possibility of art deals falling through, clients often desire to identify reserve artworks for their exchanges. They often ask how many works of art can be identified as part of a like-kind exchange. The answer is clearly stated in the Treasury regulations. The maximum number of properties that a taxpayer may identify as part of a like-kind exchange is: (1) three properties without regard to the fair market value (FMV) of the properties, or (2) any number of properties, as long as their aggregate FMV, as of the end of the identification period, doesn’t exceed 200 percent of the aggregate FMV of all the relinquished properties as of the date they were transferred by the taxpayer.10

What if I change my mind? A taxpayer executing a like-kind exchange has 45 days from the date the first relinquished property is transferred to the qualified intermediary to identify the replacement works the qualified intermediary should purchase.11 Replacement property is identified only if: (1) the taxpayer  designates it as replacement property in a signed written document and (2) that document is delivered before the end of the identification period to either the person obligated to transfer the replacement property to the taxpayer or any other person involved in the exchange other than the taxpayer.

Occasionally, clients will consider purchasing artwork from a gallery exhibition of a single artist or from a set that the artist hasn’t completed. Clients will often select a work, and then, after the 45-day deadline, they’ll change their mind and decide to purchase another work from that exhibition or that set by the same artist. Is identifying a work by an artist, but not the exact work, within the 45-day period sufficient?

The answer is “probably not.” Replacement property must be identified in the written document that unambiguously describes the property. Personal property, generally, is unambiguously described if identified by a specific description of the particular type of property. For example, a truck is unambiguously described if described by a specific make, model and year.12 Analogously, artwork can be unambiguously described by listing the artist, title, medium, size and date. The identification of a work of art by listing some of these factors, but not the title, may not be sufficient to unambiguously identify that work.

Can I use my art dealer as my qualified intermediary? Clients often want to use an art dealer they work with as their qualified intermediary for their like-kind exchanges. The client will suggest a trusted dealer, and the parties will question the need for formalities. However, the formalities and the selection of a qualified intermediary are crucial for an exchange to qualify for non-recognition of gain treatment.

Not just anyone can be a qualified intermediary. You must know the type of relationship your client has with the art dealer who agrees to serve as the intermediary. To qualify as a “qualified intermediary” for a like-kind exchange, the intermediary must not be a “disqualified person.” A person acting as the taxpayer’s employee, attorney, accountant, investment banker or broker or real estate broker within the two-year period ending on the date of the transfer of the first of the relinquished properties is treated as a “disqualified person” at the time of the transaction.13 This definition of a disqualified person may prevent an art dealer to whom your client has consigned art within the last two years from serving as the qualified intermediary for your client’s like-kind exchange. 

No matter how much your client trusts the art dealer, the parties must follow the Section 1031 formalities. The qualified intermediary must enter into a written agreement with the taxpayer. The written agreement must require the intermediary to acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property and transfer the replacement property to the taxpayer.14 

What counts as the date of completion when property is sold at auction? Relinquished works are often sold by the qualified intermediary through a public auction. When clients are calculating the 180 days in which an exchange must be completed, they often overlook the possibility of the auction house offering extended payment terms to a buyer of the client’s relinquished works.

To satisfy the 180-day time period, clients shouldn’t focus on the date of the sale, but rather the date of the final payment, because the combined time period that the relinquished property and the replacement property are held by the qualified intermediary can’t exceed 180 days.15 Generally, auction house buyer agreements indicate that title to the property sold doesn’t transfer until the auction house receives payment in full. Therefore, the date of the final payment is the date that the qualified intermediary no longer has title to the relinquished work.

What happens if I know what I want to buy, but I don’t know what I want to sell yet? A client may identify works of art to purchase before identifying works of art to sell. A taxpayer can conduct a like-kind exchange in reverse and identify a work of art to purchase before identifying a work of art to sell.16 However, in reverse exchange situations, clients are usually very eager to receive the purchased property as soon as possible, so it’s advisable to let them know up front that they won’t be able to receive the property right away.           



1. Carol Vogel, “Relentless Bidding, and Record Prices, for Contemporary Art at Christie’s Auction,” N.Y. Times (Nov. 14, 2012),

2. Internal Revenue Code Section 1411.

3. IRC Section 1(h).

4. IRC Section 1031(a)(1).

5. Treasury Regulations Section 1.183-2(b).

6. Private Letter Ruling 8127089 (1981).

7. IRC Section 1031(h)(2).

8. Internal Revenue Service Technical Advice Memorandum 200602034.

9. Committee Report Section 10,311.002.

10. Treas. Regs. Section 1.1031(k)-1(c)(4).

11. Treas. Regs. Section 1.1031(k)-1(c).  

12. Ibid.

13. Treas. Regs. Section 1.1031(k)-(1)(k).

14. Treas. Regs. Section 1.1031(k)-1(g)(4)(iii).

15. Revenue Procedure 2000-37.

16. Ibid.