Gain Today, Gone Tomorrow: Installment Sales and Other Ways to Avoid Gains

At various points collectors or gallery owners will want to turn over their art work or collectibles and acquire new pieces. If a piece is sold, it may subject a tax payer to paying taxes on capital gains (or claiming a loss). IRS Revenue Code section 1031 used to allow for the deferral of paying taxes on a capital gain (or loss) at the disposal of property if it is exchanged for a “like-kind'“ property. This used to apply to personal property, which would include artwork. However, the Tax Cuts and Jobs Act (TCJA) of 2017 eliminated this avenue for collectors and gallery owners.

There are some alternative strategies that can be used to avoid realizing a gain (or loss) all at once. First, a collector or gallery owner can use an installment sale under Internal Revenue Code 453. Instead of receiving complete payments all at once, you receive payments over time. The IRS requires a taxpayer to characterize portions of each payment as return of basis (tax free), capital gain (capital gains tax) , and interest (ordinary income tax) on the remaining balance. It is best to consult a licensed professional in order to construct and report the installment sale correctly. This cannot be used for inventory. Thus, gallery owners can use this to dispose of works that they display, but not sell.

The obvious downside to using this strategy is is that collector or gallery owner is not paid all at once. The benefit to using it is that it will allow them to stay in a lower bracket while earning even more money over time. The Net Investment Income Tax applies to individuals that earn more than $200,000. Utilizing an installment sale might allow some collectors and gallery owners to avoid this. Obviously, this strategy should only be used with buyers that collectors and gallery owners trust to follow through on all the payments.

Second, for very large capital gains collectors or gallery owners it might make sense to place the proceeds from a sale into a quailed opportunity fund. Under the TCJA qualified opportunity funds are specific funds which invest in specifically economically distressed areas in the country. Profits invested in these funds become completely tax free after 10 years (if the funds invested are withdrawn earlier a percentage of capital gains tax will be due).