Investing in collectibles, such as coins, art, wine and other tangible assets, brings with it a tax cost, since the capital gains on the sale of collectibles is at the highest (28%) federal rate (see IRC sec. 1(h)(4)(A)(i)) just as if the investor was not holding the collectible for income generating purposes, but was holding it as a hobby or as a collector.

There is an opportunity for investors in collectibles to avoid some of this tax if they act between now and the end of 2010. Here’s why:

  • A recent amendment to the Small Business Jobs Act was signed on September 27 of this year. This amendment provides that if an investor sells or exchanges Subchapter S stock (i.e. stock in a company that complies with the requirements of IRC sec. 1202) that was acquired after September 27, 2010 and before January 1, 2010 which the investor holds for more than five years, then 100% of the gain may be excluded from the taxpayer’s gross income (see IRC sec. 1202(a)(4).
  • Income retained by a Subchapter S Corporation is not taxed at the Corporate level, but the income (and allowable deductions on investments) is passed through to the shareholders on a pro rata basis and taxed as if the individual shareholders had earned the income, see IRC sec. 1366(a).
  • Actual distributions of cash or property from a Subchapter S. Corporation to shareholders are treated as dividend income if all of the shareholders consent to such an election.

The result is that if an investor who has, or wishes, to invest in art, wine or other collectibles, who buys or contributes cash or property to a Subchapter S. Corporation before January 1, 2010 could have the earnings on the investments distributed to him or her and elect to have them treated as dividends (and taxed at the 15% dividend rate) and sell or exchange the stock in the business (after five years) without incurring any capital gains.

Obviously, this is only for serious investors, who are looking to generate income from the collectibles, rather than collectors who want to “hide” their collection from the capital gains tax, since the actual actions of the business will determine if the collection is an investment or not. This would require some quick footwork and work to set up, but the tax savings may make this worthwhile for some investors.

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