Seems to me the tax folks (IRS, CRA, or equivalents in other countries) would just say “Tough. Sell some of your assets to get the cash to pay your taxes.”
I did say in my original message that you would be taxed after the painting had been formally appraised for value.
This is clearly a grey area, though. Sweat equity can be taxed without a sale taking place. If I do $20,000 of improvements to my home that causes it to be appraised at a higher value, my property taxes will increase even though I have not traded anything with anyone.
Also, ‘found’ value, such as discovering a rare antique, can be taxed, can it not? I certainly know that treasure hunters have to pay tax on their discoveries.
Also interesting on the painting concept…
If I paint a mural on my living room wall that raises my home value from $100k to $200k - I paint really nice hypothetical murals - I won’t be taxed on that $100k gain. Capital gains on the sale of a primary home are exempt (up to some limit). I suppose the same would apply if I had a struggling-but-soon-to-be-famous artist paint the mural.
Ah, ambiguity, the Devil’s volleyball!
Most of the people have parsed your painting example with reference to income tax, not property tax.
Offhand, I’m not aware of any jurisdiction that would tax an artist’s original artwork as taxable (personal) property while it’s still in the posession of the artist who created it. If you know of one, feel free to enligten me.
Cheers,
bcg
OK, after giving this a lot of thought, it occurred to me what part of the problem of my OP was. I was oversimplifying things. So let me ask this simple question, which should have a factual answer.
If I do a service for somebody, and they do a service for me, and both services have the same monetary value attached, I assume that they cancel each other out tax-wise, correct?
Would the reason be more a practical limitation? I will admit that I’m not an expert on tax policy, so maybe you can clear this up. How about the ‘found value’ argument? Found treasure is taxable - this page says that any treasure found worth over $1000 is taxable. Yet no trade took place. So I assume that if I bought a painting for $100, and then when I went to reframe it I found a million dollar Van Gogh behind the frame, I would be required to report this and pay the tax on it, would I not?
Not a chance. That’s very specifically taxable, and the IRS does a fair bit of auditing to capture exactly that scenario. There have been ‘workers co-ops’ that have tried to get away with this - you sign up with a skill, as do other people, then you barter your skills against other people’s skills (“I’ll fix your computer in exchange for you fixing my car”). You need to pay tax on the fair market value you received.
Straight from the IRS:
Mostly correct. But if the service you traded for was a business expense, then of course you could deduct that on your Sch C, along with the income. So, let us say you are a dentist and you do $500 of dental work on a plumber, who then does $500 of plumbing work on your dental office.
You add the $500 into Gross reciepts and then the plumbing work as “repairs” on Sch C, which would effectively cancel each other out. But I’ll point out that bartering isn’t magic or special here- if you just had him write you a check for $500 and then you wrote him a check for $500, you could do the same thing.
So, pulling numbers out of thin air, if somebody does a service for me, say, valued at $500, it’s a gain, but if I do that person a service valued at $500, it’s not a loss?
In my very undistinguished legal career I was never tempted to practice tax law, which has a tendency to make people short, fat, bald, and Republican (only three of those four characteristics apply to me, and I’d prefer things stay that way 
). So take anything I say on the matter with as large a grain of salt as you want.
According to IRS publication 525, Taxable and Nontaxable Income, “If you find and keep property that does not belong to you that has been lost or abandoned (treasure-trove), it is taxable to you at its fair market value in the first year it is your undisputed possession.” (My emphasis. That’s US Federal income tax, there; depending on the state that the property was found in/the finder lives in, the value of the property might well constitute state taxable income, too).
Assuming that the hypothetical Van Gogh was indeed lost or abandoned such that there is not some other owner of record with a superior claim of title to it (for such a rare work of art that would be highly unlikely, I think, but I’ll play with the facts as you give them to me), you’d have to report the fair market value (your hypothesized million dollars) less the amount paid for it ($100 in your example) as ordinary income (I’m pretty sure) in the tax year that the finder acquired the painting.
I’ll note that, for federal tax purposes, that painting’s value represents income for only that first year. However, if any taxing jurisdiction (federal, state, local) makes that painting a piece of taxable personal property, the finder might well be liable for property taxes in subsequent years, based on whatever formula personal property taxes are calculated by the taxing jurisdiction.
It’s almost always speculation to try to come up with a rationale of why a statute is the way it is, but I can think of two reasons why the legislature would decide not to tax an artist for the assessed value of a work s/he creates: First, it’s difficult to come up with a “value” for such a work until it’s sold to another party (that may be the “practical limitation” you mention, above). Second, the legislature might well realize that taxing artists on their newly created works would have a tendency to discourage them from creating new works, and that’s probably something the legislature doesn’t want to do.
Does that come close to addressing your concerns?
Cheers,
bcg
Wow, I totally didn’t see DrDeth’s post when I made mine. But I guess his response answered my question.
Found treasure is actually a pretty interesting example–you’re looking at two different cases.
First, If you find something of value, it’s taxable as income–you didn’t have anything, then you gained something valuable, and didn’t pay for it. So finding a coin with a detector is income to you right then. (on a related note, your source is wrong: all found treasure is taxable–not just treasure over $1000. If you find a dollar on the street, you’re supposed to report it on your return as income–it’s “income from whatever source derived”-which is the definition in the Tax Code.)
However, if you acquire something by purchase and then find out it’s more valuable than you thought, you don’t have income–you have unrealized gain, which is taxed when realized.
For example, you buy something worth $100, have $100 basis in it, and then find out it’s worth $1,000 (either because it becomes more valuable–say stock, or because it was sold for less than its true value–say an antique you discover to be a rare original Cecil Adams)–you have $900 of gain that you’ll have to pay tax on when you sell it (assuming you sell it for 10,000). An exception is made for cash and equivalents found in things you already own–so if you find a wad of $100 bills in that old violin, you have income–but if you find out it’s a strad, it’s not income–it’s just an appreciated asset.
ETA: bluffcityguy–the IRS distinguishes between a find (which is a straight accession to wealth) and a purchase followed by appreciation (which is treated just like any other purchase that then appreciates–so in the van gogh example, it matters if you find it or buy it)
IANAL. None of the above is tax advice.
In Sam Stone’s hypothetical, someone buys a painting for $100, and then discovers (when s/he has the painting reframed) that the purchased painting is somehow hiding a lost Van Gogh worth $1 million.
I was interpreting that as a “purchase” (of the original painting bargained and sold) and a “finding” of the hidden Van Gogh. I’m thinking that the $100 paid for the original painting might qualify as some sort of acquisition expense which would offset the fair market value of the Van Gogh (which I’m seeing as “gross income”) to arrive at the actual amount by which the finder’s net worth increased in the acquisition (“net income” or taxable income).
I’m assuming that, say, in a classic buried treasure scenario, the treasure-finder is entitled to deduct the expenses incurred in finding and uncovering the treasure. I could well be wrong (as I said, I never practiced tax law), but that sounds right to my admittedly non-expert ears.
Cheers,
bcg
BCG: here, I’m assuming the parties understood the sale to be the painting, frame, and all in between–the source of your claim to own it isn’t discovery–it’s the purchase of the painting/frame in which the van gogh was hidden–and implicitly, the seller “owned” it before you, even if he didn’t know he did. (if the seller didn’t intend to sell you everything inside the frame, he would be undoing the deal on mutual mistake grounds, and the argument the seller doesn’t “own” it is weak-- in the case of personal property we aren’t going to say you don’t really “own” the contents of a box till you open it).
Given that (which I think to be the correct characterization in the hypo), you’re not really “finding” the Van gogh out of nothing–it’s finding the package of things you bought (painting, frame, all in between) was in fact more valuable than you thought (painting, frame, van gogh). For tax purposes, no different than if you buy microsoft stock in 1981–you thought it was worth X, it was actually worth Y. Y>>>X.
Here, the IRS does distinguish between true “treasure trove”–found cash/equivalents, which are income when found (you can spend them), and valuable things that are just found (true accession to wealth) vs. property found in an asset you already purchased–which you can’t spend until you sell, and are treated as an asset.
You’re right that you do get to set the $100 purchase price against the gain of the van gogh-but it’s basis, not deduction (and hence you get to set it against the gain when you realize the asset.)
As to deductibility–generally, you can only deduct ordinary/necessary business expenses. so if you were in the business of finding treasure, maybe. But a lot of the law on business deductions turns on whether you may deduct immediately, or must capitalize the expense (add it to your basis in an asset, and then depreciate/recover the basis later.)
IANAL.
I guess this is why tax lawyers get paid the big bucks. The distinctions aren’t necessarily all that clear.
How about this: you buy a farm. Ten years later, you’re digging a well, and unearth a sculpture worth $1 million. This seems exactly analogous to buying a painting only to find a more expensive one hidden inside it. Is there a difference? Is finding treasure with my metal detector handled differently if I find it on my own property vs finding it on public land?
Now, just to throw another wrench into the works… Let’s say I dig up that sculpture, and it’s worth $1 million - but I happen to be the sculptor. It’s a long-lost piece that I had made in school, and somehow it wound up buried on my property, and after I’m well known and my works are worth zillions, I find a lost work I didn’t know still existed. NOW how am I taxed on it? And how would that be different than if I had thrown it in a trunk in my attic twenty years earlier, forgot all about it, then ‘discovered’ it when I was cleaning up to move?
Very true.
This is one on which reasonable minds could differ–and might be good on a law school exam–it looks like the painting, but it also looks like the classic treasure trove. If asked to answer the hypo, I would be minded to argue that you’re changing the character of this asset-from one piece of real property, to one piece of real and one piece of personal property (just like digging a diamond up from your land)–and that it would properly be characterized as realization (and hence taxable when found). I think the case of personal property is clear (you’re buying everything in the box, even if you don’t know what it is)–but that the case of land is less so (it’s more of a legal fiction to say you’re “buying” all the assets on the land, including plants that may blow onto the land as seeds and develop after you purchase the land) at the time of sale.
It makes a difference as to whether it’s your or common land–if it’s public land, you have no claim that you “bought” the statue with the land, and hence it ought to be treated as a newly acquired asset–you’re coming into ownership of it at the time of finding and hence, (like picking up $5 from the subway,) it’s income right there. If it’s your land, you could argue (I’m not sure you’d prevail) that you “bought” the two together unknowingly–and hence, that the IRS ought to treat the statue as an asset you own and hence are taxed on at realization. (this would lead to problems of how to split your basis between the land and the statute, and the holding period of the statue for the purposes of characterization).
Again, just talking in law-school exam hypo mode, I’d say this turns on how you got rid of the piece–if you could argue you technically never disposed of its ownership, then you ought to be treated as if you had owned it all the way through (just like in the trunk case). The best example of this would be if it was stolen from you.
If you had disposed of it, then it shouldn’t matter that you originally made it–you’d be treated as anyone else having found it, and we’d go through the analysis offered above.
If you found it on land that you bought from somebody else (and hence it came onto the land while it was somebody else’s), that would to me increase the strength of the argument that it wasn’t your property between when you got rid of it and when you found it–and that it shouldn’t be treated as if you had owned it all the way through.
IANAL, and all of this is hypothetical–nothing is offered as or intended to be tax advice of any kind.
Not really.
If you exchange personal services - you do $500 work for them and they do $500 for you - then you have done work in exchange for $500 in value and that’s income. (The same applies to them) There is no provision for deducting most personal expenses, so the $500 you received is not a loss/deduction/whatever.
It’s different if you’re exchanging business services. Let’s say you do $500 in business-related computer consulting and someone gives you $500 of business-related legal advice. Now you have business income for the $500, but you also have a legitimate (that is, ordinary and necessary) business expense. You can subtract the expense from the income and you will net out to $0 (but it should still be reported as $500 income and $500 expense, not the net of $0).
It’s also different if the services are gifts. If you do $500 in computer consulting for your neighbor without expecting any repayment, it’s neither income nor expense to either of you.
Now someone will ask “What if we pretend it’s a gift?” That’s a little like asking “What if we just don’t report our income?” You might get caught, you might not. Either way, it is not in compliance with the tax code. I won’t even try to cover the morals or the ethics of it, because that is definitely a great debate.