A 1031 exchange can apply to almost any type of investment assets, including investments in gemstones, artwork, and other tangible assets. Personal property like-kind exchange rules are somewhat different than those that apply to real estate exchanges, so it is important to use a 1031 Qualified Intermediary that has experience in these types of exchanges.
Gemstones and 1031 exchanges: a practical guide
In general, gemstones can be exchanged and the gains deferred in the same way as real estate or other investment properties. With a client selling artwork or other collectibles, the issue of whether to use a like-kind exchange can be broken down into two basic questions:
- Is there a taxable gain? Gains on long-held collectibles are taxable under IRC Sections 1(h) and 1001 at maximum federal tax rates of 28%, and state and local income taxes also may apply. Understanding the basis and having supporting evidence is key. See, e.g., Fisher, TC Memo 1986-141, where the Tax Court upheld the Service’s disallowance of the loss claimed by the taxpayer on the disposition of a stamp collection begun in his youth. The taxpayer failed to establish the collection’s basis, not having maintained records of his stamp purchases.To avoid recognizing a gain on the sale of a collectible, under IRC Section 1001, the transaction requirements are 1) the item is held for productive use in a trade or business or for investment and 2) is exchanged solely for property of a like-kind to be held either for productive use in trade or business or for investment. See IRC Section 1031(a)(1). Certain property is excluded from nonrecognition treatment pursuant to IRC Section 1031(a)(2), including stock in trade or other property held primarily for sale. Gemstones and other collectibles generally are not “excluded property” under IRC Section 1031(a)(2) unless they are inventory, so there should be no issues.
Usually, this requires spending time inventorying, aggregating, and sorting your collection in order to identify which are investments, which are a hobby, and which are decorative. Without this groundwork, it can be difficult to prove that the collectible is, indeed, an investment.
- Is there a like-kind exchange? The second tax-related issue is whether the exchange is “like-kind.” As used in IRC Section 1031(a), “like-kind” refers to the nature or character of the property and not to its grade or quality. One kind or class of property may not be exchanged for property of a different kind or class, according to Reg. 1.1031(a)-1(b). Personal property held for investment includes assets such as stamps, gems, antiques, or coins. There are limitations, however – bullion-type coins and numismatic-type coins are not of like-kind, see Rev. Ruls. 79-143, 1979-1 CB 264, and 82-96, 1982-1 CB 113. A single gemstone exchanged for a number of other gemstones by a client would constitute like-kind property, and the replacement gemstones would not have to be of the same cut or type (i.e., a faceted Tanzanite for rough emeralds) as the grade or quality of the gemstones does not matter. At this point, it seems obvious that a gemstone cannot be exchanged for an oil painting.
What is a 1031 exchange? Find out more by downloading our 1031 Exchange Solution Kit.
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