1031 Exchanges and how they apply to
Numismatic coins and Bullion.
Written by Donald W. Dee
Director - Financial Services Division
Rare Coins of New Hampshire
Just a few months ago, the Associated Press carried a story that ran in
various media outlets about a 26-year-old Montreal man who succeeded in
his quest to barter a single red paperclip for a house.[1] Kyle MacDonald, a
Canadian blogger, started with a red paperclip on July 14, 2005 and a year
later, on July 7, 2006 had traded a movie role for a two-story house in
Kipling, Saskatchewan. He reported his trades on his blog, accurately titled
“oneredpaperclip.”[2] In his penultimate trade, Kyle exchanged a KISS snow
globe with the actor Corbin Bernson for a role in his new movie. [3] The odd
trade worked because Corbin Bernson just happens to be one of the most
enthusiastic globe collectors on the planet. Kyle offered on his website “one
movie role” that consisted of (1) a paid, credited, speaking role in a film, (2)
room and board during filming, (3) return airfare from anywhere in the
world, and (4) “a high five from me, and if you’re lucky and he’s in a good
mood, Corbin Bernson.”[4] In a classic case of supply and demand, plus a
healthy dose of publicity, the town, the mayor, and the town council of
Kipling made Kyle an offer that he couldn’t refuse. Kipling offered Kyle a new
home, topped off with a key to the city. Not too bad for someone who
started off with a single paperclip and a great idea!
Bartering to bolster one’s resources is not a new concept. Collectors have
been bartering ever since there have been things to collect. Thankfully, a
provision of the tax code, Section 1031, allows participants to defer, or
sometimes even avoid capital-gains taxes when they replace assets with
similar property of equal or greater value.[5] These are called like-kind
exchanges.
The Fundamentals of a Like-Kind, Section 1031 Exchange
There are four basic requirements for a nontaxable like-kind exchange under
Section 1031. First, there must be an exchange of property. Second, the
property relinquished must qualify for exchange treatment under Section
1031. Third, the property received must be like-kind to the property
relinquished and finally, the property received in exchange must be held for
use in business or for investment.[6]
These types of exchanges have been popular with real estate because the
rapid ascent of prices in some markets have lead to big capital gains that
investors aren’t eager to pay taxes on. However, “as people grow familiar
with the tactic, and are diversifying into a wider variety of investment
assets, some are now doing trades with other types of property, including
art, collectibles, private jets, collector cars, yachts, copyrights, race horses,
even website addresses.”[7] The underlying policy is to encourage capital
reinvestment. As a result, the assets purchased must be for investment or
business purposes and not for personal use. Section 1031 exchanges provide
especially useful tax-benefits in the context of rare coins that have
appreciated in value, since the tax on capital gains for collectibles, including
coins, can reach 28%. With a Section 1031 exchange, that tax is deferred.
There are many books on rare coin investment and a survey of the literature
would go beyond the scope of this article. It is clear that the status of coins
as an investment is well-secured. Investment quality rare coins have
historically performed well over certain periods in comparison with many
other traditional investments.[8] Coins also have the benefit of being liquid
and traded in an open market. That a numismatist gets to enjoy possession
of these coins is secondary to their investment nature when proper, minimal
records are kept attesting to their status as an investment.
The wonderful thing about Section 1031 exchanges is that one can keep
“trading up” with Section 1031 exchanges and defer the taxes that would
come with the gains realized in the transfer. However, a key point of making
a successful exchange, and one that lawmakers are aware of, is that there is
a fine line between an asset, such as a coin collection, that is purchased for
investment, and one that is purchased for personal pleasure. As always,
keeping careful records can help establish the investment nature of the
property.
While the specific rules involving Section 1031 exchanges are
complicated,[9] there are some fundamentals that are consistent to all
exchanges. First is the time-frame. Sellers have 45 days to identify their
replacement property and then 180 days to complete the purchase of the
new property. And what happens if you miss the deadline? The tax break is
forfeited.
The second element is the use of a “qualified intermediary,” or a middleman.
The purpose of a “QI” is to hold the proceeds of the sale in escrow until the
new property is purchased. The “QI” is one of four parties in a typical tax
deferred exchange.[10] The second is the taxpayer who has property and
wants to exchange it for new property. The third is the seller who owns the
property that the taxpayer wants to acquire in the exchange. The final party
is the buyer who has cash who wants to acquire the taxpayer’s property.
Section 1031 Exchanges and Coins
The IRS has spoken specifically to Section 1031 Exchanges in the
numismatic context. Provided that the material is held for investment, the
IRS regulations have held that the exchange of U.S. $20 gold coins
(numismatic-type coins) for South American Krugerrand gold coins (bullion
coins) does not qualify for non-recognition of gain as a like-kind
exchange.[11] The rationale for this is that the value of numismatic-type
coins is determined by their age, the number minted, along with history, art
and aesthetics, condition, and finally, metal content. On the other hand, the
South African Krugerrand gold coins are bullion and their value is
determined solely on the basis of their metal content.[12] Additionally, the
IRS has held that the exchange of gold bullion for Canadian Maple Leaf gold
coins qualifies[13] while the exchange of gold bullion for silver bullion does
not.[14] The IRS reasoned that while silver and gold have similar qualities,
the uses of silver and gold are intrinsically different in that silver is an
industrial commodity while gold is utilized as an investment and a product in
itself. In the numismatic context, a trade of a silver numismatic coin for a
gold numismatic coin, such as a Morgan Dollar for a Saint-Gaudens Double
Eagle, is likely permitted. Although one is silver and the other is gold, both
are valued for their numismatic worth as well as their metal content.
An Example of a Section 1031 Exchange in the Numismatic Context
Suppose a numismatist purchases (for investment purposes), a group of one
hundred Saint-Gaudens Double Eagle gold coins for $100,000 and the group
now has a value of $250,000. If the numismatist sells his property for cash,
he will recognize a gain of $150,000 that is subject to taxation. However, if
the numismatist properly makes a Section 1031 exchange through a QI, he
can exchange those hundred Double Eagles for a single gold coin with value
of $250,000 (of course, under the caveat that he intends to hold it for
investment), and defer paying taxes on the gains until he elects to sell the
new coin. However, if that coin with a basis of $250,000 rises in value to
$500,000, the numismatist can then change it again for a group of 500
Double Eagles with a value of $1,000 each (again, provided that he follows
the technical requirements of a Section 1031 exchange and keeps
documentation supporting that the coins were held for investment.)
Conclusion
Like-kind exchanges under Section 1031 are one of the last strategies
available to defer capital gain taxes on the disposition of qualifying property.
Selling or disposing of appreciated investment property typically leads to
Federal and state capital gain taxes. These taxes leave an investor with less
to re-invest and make it difficult for taxpayers to trade-up in value, and
ultimately increase their net-worth. Unfortunately for Kyle MacDonald,
trading a paperclip for a house, or a paperclip for a Morgan Dollar, would not
be viewed by the IRS as a like-kind exchange under Section 1031. A Section
1031 exchange allows a taxpayer to reallocate, consolidate, or diversify his
or her investment properties without having to pay tax on any capital gains.
The same principles that are applied in the exchange of real estate can be
applied to coins. In the numismatic context, provided that there is adequate
documentation to identify the coins as being held for investment, an
exchange under Section 1031 can be a collector’s good friend, and can allow
a collector to trade-up, while deferring taxes.
