The sale of Paul Newman’s Rolex Daytona replica watches made headlines around the world, not only because of its heritage but also for the record-breaking price it commanded. For the buyer of this watch, and the buyers of any other watch at auction, there is more to it then just pay the hammer price and the premium. Taxes are also an important consideration or should be at least as it can save you quite a bit of money when you plan ahead.
About this, we talked with David Lehn, Tax Partner at Withers Bergman, who provides us an insight into how to become an “investor” in the eyes of the IRS, or how to ensure that you can bequeath a watch collection to the next generation without giving them a tax burden as well.
How can the potential buyers mitigate the tax burden of a purchase like the Paul Newman watch?
The immediate tax burden is the sales tax. This may be avoided by a purchase for use in a state with no sales tax, provided that the delivery is in that state. Some individuals have sought to avoid the sales tax by establishing “warehouses” in sales tax-free states. The states are aggressive in pursuing these cases, with criminal consequences.
The purchaser may need to sell other items to raise the funds for the cheap replica Rolex watches purchase. These sales may produce an income tax burden. Avoiding this income tax burden is possible if the individual is an “investor” for IRS purposes and the individual can facilitate like kind exchanges (discussed below).
Finally, while not immediately helpful, the individual should consider becoming an investor to take advantage of deducting future expenses and losses, and taking advantage of like kind exchange opportunities in the future.
What are “like-kind” exchanges and how can they be taken advantage of in this situation?
The like-kind exchange is, without question, the greatest existing tax dodge. Most commonly associated with real estate investors, it allows for the deferral of taxable income on the sale of a collectible by an investor (but NOT a collector/hobbyist). This happens by investing the sales proceeds in a similar investment. There are many complicated rules. The two most important are determining a “like kind” item and the timing on sale and purchase. Like kind items means a watch for a watch (and not for a car or a collection of wine). Timing issues include the 45-day period after a sale to “identity” the new item to purchase and 180 days to close. (It is possible to purchase the 2nd item before selling the first.). Most importantly, the seller (and their attorney) are not permitted to “touch the sales proceeds”. Originally, the concept of a like kind exchange was just 2 parties swapping properties. That rarely happens today. Like kind exchanges are generally “3 party exchanges”. Fortunately, there are intermediary companies that specialize in this process, holding the funds, and guiding the investor on the like kind process (but not the complicated investor rules and other tax issues), generally at a very inexpensive cost.
What constitutes an investor or collector in the eyes of the IRS?
The IRS’ “fault line” is whether the activity is to make money (an investor) or is it just a habit or hobby (a collector or hobbyist). The IRS considers more than a dozen factors and does not weigh the factors equally or even in the same manner in different cases. So it is clearly an uphill battle.
The best copy Rolex things approach is to establish a separate entity (like an LLC) with a separate bank account, maintain meticulous records (research, education, considerations in investment, travel, amount of time spent doing ANYTHING related to the investment, etc.), occasionally hire an expert and, since there is a “presumption” of investor status if there is gain in 3 of 5 tax years, time sales to meet this presumption (also, keep records showing year end values that indicate an annual and cumulative “paper profit”).
Obviously, this can take much of the fun out of the activity. But, it can provide substantial tax benefits.
In addition to taking advantage of like kind exchanges, investors may deduct losses on sales and also deduct certain expenses. These opportunities are not available to collectors/hobbyists.