When Doing a Trade

[BobC]

Originally Posted by Exhibitman

Bob, isn't the outcome taxable but effectively tax neutral if the parties trade evenly valued items? Isn't the income on that deal zero?

Hi Adam,

You and I decide to trade cards that are both currently worth $1,000 each. I acquired mine about 20 years ago, already in an SGC slab, and paid $350 total for it back then, which included S&H. The card you're trading to me, you acquired raw 7 years ago for $450, which also includes the shipping and handling. You subsequently sent your card in to PSA to have it slabbed, and paid $35 for the grading of the card at that time, plus an additional $10 for the postage, there and back, to have the card graded and returned to you. And we do the trade remotely so we both mail the cards to each other, and the tracking, insurance, and everything costs each of us $12.

So on my side of the trade, I get $1,000, the current value of the card you sent me. I offset that by the $350 in total I paid to acquire the card I traded to you for it, and further offset the value of the card you sent me by the $12 in postage and related costs to send you my card in trade. I end up with a taxable gain of $638 ($1,000 - $350 - $12) to report on my tax return. The tax basis of the card I traded you for is $1,000 in my hands.

On your side of the trade, you also get a card currently valued at $1,000. That is offset by the $450 you paid to originally acquire the card you traded me, along with the $35 you paid to have the card subsequently graded and the additional $10 in postage you spent to do so, and finally by the $12 in postage and related costs you spent to send me the card you traded to me. You end up with a reportable taxable gain of $403 ($1,000 - $450 - $35 - $10 - $12). And the tax basis of the card you traded me for is also now $1,000 in your hands.

The actual amount of federal tax (not even going to try to go into state and local income taxes or sales/use taxes) each of us would end up owing on our reported taxable gains would be dependent on what tax bracket we each end up in on our respective federal income tax returns. And that would be further dependent on our filing status (married, single, etc.), and all the other taxable income and deductible expenses we report on those federal income tax returns.

Oh, and to just slightly complicate matters further, the amount of federal income tax we would owe on those gains can also vary depending on whether or not the cards we traded were held by us as dealers, investors, or true collectors/hobbyists. If either of us held the cards we traded as collectors or investors, the resulting gains from our trades would be considered capital gains. And then depending on how long we had owned and held the cards before we traded, those could end up being either long-term capital gains or short term capital gains. The difference being that if we had held and owned the cards we traded for less than a year, our gains would be considered short-term taxable gains, and the resulting taxable income treated as ordinary income (like W-2 wages) and taxed at up to the highest marginal tax rate there is for individuals. In my example we both held the cards we traded for over a year, so those would both be considered long-term taxable gains, where the maximum federal tax rate either of us would pay on those LT gains would be capped at no more than 28%, because we were dealing in what are considered collectibles.

Now if either of us was a dealer and the card we traded was part of our inventory, that's a whole other story. The gain we had on the trade is no longer capital gain, it is all ordinary income, subject to federal income tax up to the highest tax rate there is for whatever basis we file a tax return under. By this I mean that if either of us did the trade as a dealer, our business could be set up to where instead of reporting our resultant taxable gains directly on an Individual federal income tax return (Form 1040), our business/dealership might be set up to where the taxable gain on the trade gets initially reported on a Partnership (Form 1065), Corporation (Form 1120), or S-Corporation (Form 1120-S) federal tax return. Not even going to try to start explaining all the differences initially having to file and report the taxable gain from our trade on one of these other returns would entail.

There is a positive thing if either of us do end up reporting such a transaction as a dealer though, and that is that we would also get to additionally deduct the expenses of running our business/dealership though our tax returns (utilities, rent, supplies, R&M, etc.), and thereby further reduce the amount of taxable gain we would otherwise have to pay income tax on if we reported the trade as an investor or collector/hobbyist instead. But there's also a potential downside in reporting as a dealer because as a dealer, you may also be liable for self-employment tax (social security and Medicare tax) of up to 15.3% on your reported taxable income/gain from this trade. And that is on top of whatever federal income tax you may owe on that income. And the self-employment tax would normally kick in and be applicable if you initially filed and reported the income from such a trade on an Individual or Partnership tax return (Forms 1040 and 1065), but not if you if you initially filed and reported it on a Corporation or S-Corporation tax return (Forms 1120 and 1120).

So there is the "short", but at least fairly complete, answer to your comment/question. (Believe me, it can get even more involved and complicated than this.) And this demonstrates exactly why no one ever wants to report their trades on their tax returns, it can be one huge pain in the butt. But this is generally what you are supposed to do, even when just trading cards with no cash involved.

And for those posting about how dealers always seem to try and take advantage of you in trades, I'm not defending anybody, but part of their reasoning for maybe doing that is they are more likely to actually report such activity on their tax returns (or at least on the subsequent sales of cards you traded to them), and that they may also then owe additional self-employment tax on top of regular income taxes as well. And since some individual just trading with a dealer isn't likely going to report that trade for tax purposes, they aren't going to worry or think for a second about how to come up with the cash to then pay the resulting tax(es) due. This is another potential downside of doing trades with no cash involved. You can end up generating what I call phantom taxable income, but generate no cash from the deal with which to pay the taxes now due.

And finally, if nothing else, this may give someone reading all this a little more understanding and appreciation for their accountant/tax preparer when they just dump all their tax info on them a few days before the filing deadline every year.