Taxpayers are usually taxed on net gains from the sale of property. However, tax may be deferred if the transaction is cast as an exchange and certain conditions are met. Code §1031 like-kind exchanges are commonly used in the real estate business to defer taxes arising from the disposition of appreciated property in return for replacement property of similar character and use. Deferral of tax is allowed even when the exchange looks like a sale because it is part of a three-party arrangement where the purchaser provides cash to a qualified intermediary, who is acting on behalf of the transferor, and that intermediary uses the cash to acquire replacement property for the transferor.
Reportedly, art investors are now employing like-kind exchanges to defer tax on gains from the sale of appreciated art. The tax is deferred by exchanging art for art. This article looks at like-kind exchanges and how the stringent requirements have been adapted by art investors.
Under §1001(a), taxable gain or loss from the sale or disposition of property is defined as the difference between the amount realized from the disposition and the adjusted basis of the property. To constitute a realizable event, the properties exchanged in the transaction must be materially different. The simplest example is an exchange of real estate in return for cash. A more complex example is an exchange of real estate for a sail boat. In both these instances, the properties are materially different and the holder of the property ends up holding assets that are different in kind or extent from the asset transferred.