Art Market May Lose ‘Driving Force’ as Tax Plan Targets Loophole

(Bloomberg) -- A legal tax loophole that has fueled the U.S. art market may go away as part of the proposed tax reform.

Artworks would not qualify for what’s called a 1031 like-kind exchange if the proposed tax bill, released Thursday by the U.S. House of Representatives, is passed. The legislation would limit the tax break to real estate rather than the broader group of investments to which it currently applies, said William J. Kambas, a partner at Withers Bergman LLP who focuses on wealth planning and taxes.

The loophole has been “a -- or even the -- driving force for the top end of the U.S. art market,” said Josh Baer, publisher of the art industry newsletter Baer Faxt.

Since 1921, section 1031 of the Internal Revenue Code has enabled investors to defer paying capital gains taxes on the sale of certain assets, if they roll the profit back into a similar type of business or investment. Most commonly used in real estate, the exchanges have also been done with race horses and airplanes. Since the 1980s, as prices for artworks rose, many people have applied the strategy to their Warhols and Picassos, too.

Wealthy collectors have saved millions of dollars with this tax break by selling a painting and transferring its gains into the purchase of another.

The repeal could have a major impact on the market. Short-term, it will increase the velocity of transactions, Sotheby’s Chief Operating Officer Adam Chinn said Friday on a call with investors.

“You might see a lot of transactions between now and year’s end,” he said.

That’s because the proposed tax change wouldn’t go into effect until Jan. 1, 2018, according to the proposal Thursday. As a result, investors may want to consider accelerating any foreseeable 1031 like-kind exchanges to occur in this year, Diana Wierbicki, a partner at Withers Bergman LLP who specializes in art law, said in a report Thursday.

Long-term, the impact would be mildly negative, said Chinn, adding “and then the market will get used to the fact you have to pay taxes on the sale of art.”

But the final bill from Congress may look different, said Kambas.

“There’s still a lot of horse trading to go on," he said.

©2017 Bloomberg L.P.

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