THE ABC’S OF INCOME TAXES AND COIN COLLECTING
When It Comes to Taxes, the Alphabet Is Only The Beginning
Coin collecting is a very non-financial but financially rewarding hobby or investment. Over time, some collectors can create great wealth with coin collecting. While coin collecting can earn a collector a profit, sometimes a handsome one, some very serious income tax consequences cannot be overlooked. Let’s start with an example: A collector named Sam desires to create an Indian Head cent collection. Indian Head cents were minted from 1859 until 1909 by the U.S. Mint. Sam attends a coin show and buys an Indian Head cent for $750 from a dealer. The following month, Sam goes to another show and sees an upgrade to the Indian Head that he previously purchased, this coin priced at $1,500, but the price is more than he wants to spend. So, the selling dealer suggests trading the coin that Sam owns by giving a trade-in allowance of $850, with Sam adding $650 cash. Sam agrees to the trade and gets his upgrade. After collecting for several months and buying coins for his collection, Sam sees a Bust coin and desires to collect Bust coinage, but he realizes he cannot collect both Indian Head cents and Bust coinage due to budgetary means. So, at the next show, Sam sees that wonderful Bust coin that he has to have. So once again, Sam wants to trade an Indian Head cent to the dealer, but the dealer does not want to do
the trade. Sam sells his collection to another person for cash, then purchases that Bust coin to start his new set. Sam is a thrilled and very proud owner of the storied Bust coin, but innocently enough, Sam does not realize that the events that occurred carry income tax consequences. At tax time, Sam talks to his tax accountant about how he acquired the Bust coin. The tax accountant is happy about Sam’s new addition but now has to explain the income tax implications to Sam. The first question the accountant asks Sam is whether he was buying the coins for a hobby or as an investment, a thought that never entered Sam’s mind. To determine if coins are considered an investment, Sam depends on his personal goals for his collection. If Sam is buying coins purely for pleasure and does not seek a profit, then it’s clearly a hobby. If Sam is buying coins solely to seek profits, then Sam is an investor. Typically, most collectors collect coins for a combination of reasons, including both - pleasure and profit. In these cases, the income tax laws aren’t so clear as to whether Sam is a hobbyist or investor. Let us review the rules. First, if Sam is collecting coins solely for personal reasons, it’s a hobby; and any time Sam sells a coin for a profit, it’s subject to tax. The amount of income subject to tax is the difference between how much Sam sold the coin for less the price he paid. If Sam sells the coin for less than he paid, then the loss is
considered a personal loss and not deductible. Additionally, if there are any expenses, he spends to maintain his hobby, then those expenses are not deductible either. Let us say Sam is collecting coins not as a hobby but for investment purposes. If Sam sells a coin for a profit or a loss, then those gains or losses are subject to income taxes. Besides, buying and selling coins, Sam incurs some investment expenses (i.e. travel costs to attend shows). Before 2018, these expenses were deductible as investment expenses, but effective 2018, the Tax Cuts and Jobs Act (“the Tax Act”) mandates that these investment expenses are no longer tax-deductible. Whether a hobbyist or collector, the coins in Sam’s collection are considered a capital asset under the income tax laws. Accordingly, gains from the sale of a capital asset are either considered short term or long term. Long term capital gains are taxed at a lower tax rate than short term gains. Long term is when Sam owns the coin sold for greater than one year. The long-term capital gain tax rate for the sale of collectibles (i.e. coins) is capped at 28%. If Sam is an investor and sells any coin at a loss, then he can offset the losses against any capital gains, including stock gains during the year and save income taxes. Now let’s go back to when Sam the investor upgraded his $750 Indian cent, for another Indian head cent. Before 2018, any trade-in gains were not subject to income taxes under the tax-free exchange rules. However, the Tax Act no longer permits any tax deferrals in trades for coins. Therefore, Sam is required to recognize a taxable income of $100 for the trade-in allowance. To comply with the income tax laws and report the correct amount of income, Sam’s accountant suggests the following: • Sam needs to understand whether he is considered a hobbyist or an investor and properly report any sale of coins on his income tax returns. In cases where Sam desires to be an investor, and it may not be that clear under the tax laws, then Sam should purchase business cards stating his investor status. • Sam needs to maintain detailed records of all his coin purchases and sales. These records can be maintained on an Excel schedule or manual records, but at the minimum should contain the date each coin was purchased, from whom and the price paid. Also, it’s best to keep a copy of the purchase invoice within the records. For any coins sold, you should indicate in your records, the date sold along with its selling price and who purchased the coin. If you sold the coin to a dealer or through an auction house, then you should obtain an invoice to support the sale. These records should be maintained for seven years just in case of an IRS audit to support your return. • Included in the accounting records, Sam should maintain a detailed list of all of his coin holdings. This list should be maintained in a different location from where the coins are stored. • Depending on the value of the coins, Sam should maintain insurance for his coins. This is a non-tax recommendation. • Depending on the number of coin purchases and sales, Sam should maintain a separate bank account to avoid the commingling of the coin buys and sales from his expenses. Following this advice should help to protect collectors and investors from having a bad experience with regard to taxes.