By Jennie Nadel.

What’s new in tax law and how can this affect the art world? To defer taxes as before, art owners can now sell art and invest in real estate in low-income zones located in all 50 states. The following study examines the changed tax law landscape and its impact and potential implementation in the art market.

Part I. Like-Kind Exchange

It went out not with a bang but with a whisper, the great money saving plan for art collectors.

Section 1031 in the IRS Text Code with the full title of 26 U.S.C. § 1031 concerns investment and business property. Known under the name of “1031 Exchange” or “like-kind exchange,” the old Section 1031 of the Internal Revenue Code was most often thought to concern farming equipment and real estate transactions. In theory, one could buy a piece of investment property, such as real estate, sell it, and immediately buy another using the proceeds of the sale, thereby avoiding capital gain taxes until finally selling for cash. This permitted taxpayers to continuously (re)invest in property without worrying about taxes. This was also used to the advantage of those interested in investing in works of art. Until 2018, certain sales and purchases of paintings would fall under this exception of real property and Section 1031 was routinely used to roll over the gain from one piece of artwork to another. It was famously used by actress “Baby” Jane Holzer in 2013, who ended up suing her gallerist, Stephan Stoyanov as a result of a failed tax savings efforts.[i] If used correctly, the 1031 ensured that the total net equity of the appreciated asset’s value was put towards a “like-kind” work of art. The purpose of applying 1031 treatment to art market transactions was to delay taxes by buying another work of art and end up paying taxes only once as long-term capital gain.

A Quick History of 1031

The first income tax code adopted by United States Congress was The Revenue Act of 1918; however, The Revenue Act of 1921 amended the previous act and included the first tax-deferred like-kind exchange under section 202(c) of the Internal Revenue Code. The Revenue Act of 1924 established the U.S. Board of Tax Appeals under Congress and eliminated non-like-kind property provisions allowed in the 1921. In 1935, the U.S. Board of Tax Appeals approved the first tax-deferred like-kind-exchange with the use of a qualified intermediary. Further precedent in how delayed tax-deferred like-kind exchange transactions was made following a 1979 court case Starker v. United States.[ii] As a result, in 1984, Congress restricted time limitations in which a deferred exchange could occur – the investor has 45 days to find a replacement property and 180 days to acquire it.

In 2004, the IRS Office of Research, Analysis, and Statistics reported that taxpayers filed more than 338,500 Forms 8824 claiming deferred gains or losses of more than $73.8 billion.[iii] Since 1998, the amount of taxpayers filing like-kind exchanges had doubled while the dollar amount had tripled.

Nearly 100 Years of 1031: The Way it Worked Until it Didn’t

When selling property, a person would designate the like-kind replacement property to a qualified intermediary who received the cash. Within 45 days of the sale, the buyer had to designate the replacement property, such as a property of higher value, in writing to the intermediary specifying the property sought to be acquired. Within 6 months, or 180 days, of selling the property, the seller/buyer had to close on the new work. Collectors later realized that they could use this tax loophole for works they bought that had significantly appreciated in value. They could sell works and invest in a new work, aka “flip”, without having to pay capital gains tax on the appreciated value, thereby getting a better return on their investment. Furthermore, there is no limit to how many times a seller could implement the 1031 Exchange.

However, as of December 22, 2017, the date the 2018 Tax Cut and Jobs Act was signed into law, Section 1031 exchanges were relegated to apply to qualified real estate or “real property.”[iv] Other types of property:  intellectual properties, machinery and equipment, as well as artworks and collectibles no longer qualify for the tax-deferred exchanges.[v]

1031 Replacement – From Art to Real Estate, an Introduction to Opportunity Zones

The 2018 Tax Cut and Jobs Act (TCJA) was passed under the Trump administration in the 115th United States Congress and was signed in as law on December 22, 2017. It included a transition rule that permits a 1031 exchange of qualified personal property in 2018, only if the work was acquired by December 31, 2017. This new piece of legislation has made very large changes in the tax legislation. If you are interested in learning more outside the scope of the art world read more here and here.

Opportunity Zones 101

Now that the 1031 tax law is no longer available for art collectors to take advantage of, the TCJA offers a new and unexpected way to take advantage of tax breaks through “Opportunity Zones.” Opportunity Zones were originally introduced in the Investing in Opportunity ACT (IIOA) in February 2017 during the 115th Congress and sponsored by Senator Tim Scott. These zones are outlined as low-income communities where new investments can earn preferred tax treatment. The goal of these Opportunity Zones is to create new development in poorer areas and there are now opportunity zones located in all 50 states.[vi] These investments in Opportunity Zones that are aimed to push development can come from the sale of an appreciated asset such as real estate but it also applies to artworks.

The TCJA is only applied if the work of art appreciates in value. Collectors who are interested in selling a work worth more than when they bought it can benefit like they did in the 1031 exchange by temporarily deferring their capital gains tax. Opportunity Zones allow for a collector to invest proceeds from a sale of an artwork into one of these zones by placing their invested gains in a Qualified Opportunity Fund (QOF), thereby shifting money from the art market to the real estate market.[vii] However, it is important for any collector interested in using this “loophole” to defer capital gain tax to understanding how it works. The collector first must find a fund developed by a trusted real estate firm or developer in which they can safely place their investment or create and register their own QOF. The collector is also thereby transferring his or her money into the real estate market, unlike the 1031, which allowed him or her to make like-kind purchases. Furthermore, the investment must remain in these Opportunity Zones for longer than five years to qualify for a 10% exclusion of the deferred gain. If If the investment is held in the QOF for 7 years, an extra 5% is added. Lastly, if the investor holds the investment for at least 10 years, him or her is eligible for an increase in the basis of the QOF equal to its fair market value the date that the QOF is sold or exchanged. This might not be as appealing or difficult to navigate for collectors familiar to Section 1031, but the new business opportunity may entice alternative solutions now that tax-free art exchanges are no longer available.

About Opportunity Zones: a Pro for Real Estate Investors and a Potential Con for Art Lovers

While investing in Opportunity Zones may seem appealing to some, art investors should know what they are getting themselves into. Firstly, anyone looking to sell their artwork may defer their capital gain taxes, but they are no longer participating in the art market and are shifting their money into the real estate market, less glitzy more gritty. Furthermore, it is key that investors know which QOF is right to invest in. This might be appealing to those who straddle both worlds in terms of their investment behavior but it might not appeal to all who prefer to use the appreciated value of their artwork on buying new works. Some collectors are simply selling a work from their collection to finance their next exciting work of art; this exchange may potentially be more appealing to those who are more focused on art as an investment potential.

Furthermore, Opportunity Zones are posed as an incentive for large investors to pour money into low-income neighborhoods, thereby hopefully increasing employment and gentrification in those neighborhoods. One has to wonder if these zones are really meant to help impoverished areas or provide incentives to already wealthy investors by cutting them a tax break. Perhaps investing money in low-income neighborhoods would be more effective than simply cutting a tax break. Lastly as stated in the Center on Budget and Policy Priorities, the tax break provides no requirements that investors have to benefit the low-income communities or their residents in which they are entering. Read more about potential flaws outside of the impact on the art market here and here.

Part 2. State Sales Tax – South Dakota v. Wayfair  

A Brief Background on Sales Tax

Sales tax laws for individual states are not subject to federal regulation. Rather, they are decided by each state. They are typically imposed on retail transactions and other services. For example, the base sale tax in New York State is 4.5% under New York Tax Law Section 1107. but certain municipalities and counties impose an additional surtax, making New York City’s sales tax 8.875%. As of 2019, Alaska, Delaware, Montana, New Hampshire, and Oregon did not impose state sales taxes. Read more about their specific regulation on their excise and income taxes here.

Because states like Delaware do not have a sales tax, they have become a prime location for out-of-state art collectors and investors to bring their artworks. Since 2014, New Castle Country, Delaware had seen a proliferation of art storage companies such as Delaware Freeport and Atelier Art Storage and Services. Art buyers can ship their costly artworks directly to storage facilities in Delaware and avoid paying sales tax for as long as the items remain there. In 2018 New York also recently acquired its first and only federally-designated Foreign Trade Zone storage facility called ARCIS. Located in Harlem, the works stored inside are not considered within U.S. customs territory. However, those who buy art in New York still have to pay local state taxes even if the works are stored in a Foreign Trade Zone like ARCIS. While New York offers a potentially more prestigious and convenient location in relationship to the art world, while both freeports are Foreign Trade Zones, Delaware is able to capitalize off of the tax breaks offered by the state. This is because FTZs waive federal customs duties but don’t eliminate state or city sales and use taxes.

South Dakota v. Wayfair

In a recent U.S. Supreme Court case – South Dakota v. Wayfair,[viii] the major retail site for furniture and homegoods was forced to charge sales tax to out-of-state purchasers. A previous Supreme Court ruling in 1992, Quill Corp v. North Dakota,[ix] set precedent.The Supreme court reversed the decision of the lower court, which was largely based on the outcome of National Bellas Hess, Inc. v. Department of Revenue of Illinois.[x] The lower court ruled that a “seller whose only connection with customers in the State is by common carrier or the … mail” was not forced to charge sales tax as it violated the U.S. Constitution’s Fourteenth Amendment by creating an unconstitutional burden on interstate commerce. The Supreme Court reversed this decision stating there is need for “physical presence” in a state for there to be sufficient reason to collect and pay state tax.

South Dakota v. Wayfair sets a new precedent following these two earlier court decisions. This has been called the “economic nexus” as more and more items are purchased by buyers in different states, especially with the rise of online shopping. Wayfair argued that the Dormant Commerce Clause of the U.S. Constitution[xi] prohibits states from imposing excessive burdens on interstate commerce without congressional approval. Previously, sellers only had to collect or pay sales tax if they had a physical presence in the state, as decided in Quill Corp. In a 5-4 decision, the Supreme Court replaced the “physical presence” rule with the “economic nexus” rule: in which sellers in one state make a certain amount of transactions in other states. The economic nexus notes that retailers are increasingly providing goods and services through interstate commerce and previously the dormant commerce clause was giving an unfair advantage to those with a physical presence.

Putting It All Together

The Wayfair decision could have major ramifications on how states collect sales tax and on the business of art. Sales tax was usually applied based on where the buyer takes ownership of the work, based on the physical presence of the seller in the state. This is how dealers could ship sold artworks to collectors in other states without having to worry about taking on the burden of the collector’s local state tax.

Currently, of the 45 states that impose general sales tax, 39 have either enacted or proposed legislation incorporating this new “economic nexus” rule. These state taxes can vary in price drastically. For example, a work shipped to one state might only require sales tax on an item valued at over $1 million while another might tax on any items over $100,000. This means that galleries will now need to consider a state’s sales tax when selling works to buyers who require out-of-state shipping.

When it comes to the sales of goods of high monetary value, taxes are inevitable, artwork included. Investors in art, such as dealers and collectors have found ways to avoid capital gains tax where they can through the landscape of federal and state tax law, but this is changing as previous loopholes are closing. The recent decision of South Dakota v. Wayfair reflects the increasingly expansive sale of goods by means of online transactions. While this decision was not meant for the sale of fine art, this could very well be a subsequent consequence. It forces art market participants to think of fine art, not just as something decorative, beautiful, inspirational but as an asset of potentially high value with equally high stakes ramifications.


[i] Michael Schwartz, The Art Of The Tax-Free Exchange, Forbes (June 4, 2018). Here. Adam Klasfeld, $585,000 Bubble Gum Art Deal Blows Up, Courthouse News (May 23, 2013). Here.

[ii] Starker v. United States, 602 F.2d 1341 (9th Cir. 1979). Here.

[iii] Report by the Department of Treasury 2007-30-172, Like-Kind Exchanges Require Oversight to Ensure Taxpayer Compliance (Sept 17, 2007). Here.

[iv] Tax Cuts and Jobs Act of 2017, I.R.C. § 13101 (1986). Here.

[v] Ibid. and IRS, New rules and limitations for depreciation and expensing under the Tax Cuts and Jobs Act, IRS (2018). Here.

[vi] I.R.C § 1400Z-1. Here.

[vii] Anna Bahney, Can average investors take advantage of a new real estate development tax break?, CNN Business (Dec. 6, 2018). Here.

[viii] South Dakota v. Wayfair, Inc., 585 U.S. ___ (2018). Available here.

[ix] Quill Corp v. North Dakota, 504 U.S. 298 (1992).

[x] National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967).

[xi] U.S. Const., art. I, § 8, cl. 3. Here

Suggesting Readings:

  • Anna Bahney, Can average investors take advantage of a new real estate development tax break? , The New York Times (Dec. 6, 2018). Available here.
  • Doug Woodham, The Tax Strategy That Fuels the Art Market – and That May Be about to End, Artsy (Nov. 7, 2017). Available here.
  • Eileen Kinsella, Introducing ‘Opportunity Zones’: The Trump Administration’s New Tax Break for Art Collectors” Artnet News (Jan. 14, 2019). Available here.
  • Elie Rieder, The Significance Of Investing In Opportunity Zones, Forbes (Dec. 7, 2018). Available here.
  • Graham Bowley, Tax Break Used by Investors in Flipping Art Faces Scrutiny, The New York Times (Apr. 26, 2015). Available here.
  • Joseph Bishop-Henchman, The Potential Outcomes of the Wayfair Online Sales Tax Case, Tax Foundation, (Jun. 11, 2018). Available here.
  • Margaret Carrigan, The tax man commeth: new laws on sales tax pose problems for US art dealers, The Art Newspaper (Dec. 5, 2018). Available here.
  • Margie Fishman and Scott Goss, Delaware provides tax shelter for multimillion-dollar masterpieces, Delaware Online (Sept. 27, 2017). Available here.
  • Mark Schoeff Jr., Taking advantage of opportunity zone investments for tax breaks requires high risk tolerance, InvestmentNews (Oct. 22, 2018). Available here.
  • Michael S. Schwartz, The Art of The Tax-Free Exchange, Forbes (Jun. 4, 2018). Available here.
  • Paul Sullivan, How the Tax Code Rewrite Favors Real Estate Over Art, The New York Times (Jan. 12, 2018). Available here.
  • Robert W. Wood, 7 Key Rules About 1031 Exchanges — Before They’re Repealed, Forbes(Mar. 10, 2014). Available here.
  • Robert W. Wood, 1031 Exchanges: 10 Things to Know, Investopedia (Feb. 6, 2019) Available here.
  • Roy G. Blakey, The Revenue Act of 1921, The American Economic Review 12, 1, 75-108 (1922) JSTOR. Available here.
  • Samantha Jacoby, Potential Flaws of Opportunity Zones Loom, as Do Large-Scale Tax Avoidance, Center on Budget and Policy Priorities (Jan. 11, 2019).
  • South Dakota v. Wayfair, Inc., 585 U.S. ___ (2018). Available here.
  • South Dakota v. Wayfair, Inc, Oyez (last visited Feb 19, 2019). Available here.
  • Tatiana Kimbo and Richard Phillips, How Opportunity Zones Benefit Investors and Promote Displacement, Institute on Taxation and Economic Policy (Aug. 10, 2018). Available here.
  • Timothy Weaver, The Problem with Opportunity Zones, CityLab, (May 16 2018). Available here.

About the Author: Jennie Nadel is a Spring 2019 intern; she also served as our Summer 2018 post-graduate intern. She graduated from Johns Hopkins University majoring in History of Art with a double minor in Museums & Society and Visual Arts. She is currently pursuing her M.A. in Art Business at Sotheby’s Institute.

Disclaimer: This article is for educational purposes only and is not meant to provide legal advice. Readers should not construe or rely on any comment or statement in this article as legal advice. Opinions expressed here are those of the author.