Among the dramatic changes to be wrought by the landmark revision of the Internal Revenue Code (“Code”) just signed into law is a major change to the longstanding ability, under Section 1031 of the Code to defer paying capital gains taxes on the sale of certain assets, if the profit is rolled back into a similar type of business or investment. To claim the benefits of the like-kind exchange, the taxpayer had to be able to substantiate that the asset in question was purchased and held primarily for investment purposes or use in a trade or business.

While the 1031 like-kind exchange has most commonly been utilized with real estate investments, the technique has been used with other assets as well. In the last thirty-five years, as prices for artworks have risen dramatically, collectors at the top-end of the market have used the 1031 like-kind exchange to save millions of dollars in taxes by selling, for example, a painting and transferring the gain into the purchase of another painting.

The new Internal Revenue Code restricts the use of the 1031 like-kind exchange solely to real estate investments. While it is too early to gauge the impact of the change on the art market, the inability to utilize the 1031 like-kind exchange is likely to have a negative impact on high-end art transactions.