Tax and bartering

By Roy Ice

Past articles were focused on tax planning and awareness of changing legislation and full of optimism. January 2020 seems so long ago; we were all so innocent back then.

Since that time, there has been a LOT of bad news. Raise your hand if you considered tilling the back yard and raising chickens because, the way things were going, we were on a trajectory back to medieval times and you just might have to barter trade for a roll of T.P.

Speaking of bartering, I am reminded of the story of the Canadian radio personality who traded a paperclip for a house. If you have never heard of the red paperclip or Kyle Macdonald, you should check it out. As I am writing this, it is currently safe to Google “red paper clip,” but it’s the internet … so, you know, be careful. Anyway, the gist of the story is that an individual traded up from a paper clip to a pen and then on to a hand-sculpted doorknob and so on until he found himself the owner of an actual two-story farmhouse in Kipling, Saskatchewan.

This socioeconomic experiment took a total of 14 trades over the span of one year, which is an accomplishment in its own right. It got me thinking: “What would the tax be on that?” (I do realize normal people don’t think this way; but I am a tax nerd so you don’t have to be). Assuming Kyle’s story took place in the U.S., the relevant guidance resides at IRC code §61 which states that gross income means all income from whatever source derived, valued at fair market value at the date of the transaction. This means that even “found property” like a $20 bill picked up on the street is technically taxable. I doubt that trading a paper clip for a pen would raise many eyebrows at the IRS. Such a transaction would be considered de minimis, or too trivial or minor to merit consideration. However, looking at the big picture, going from a paper clip to a house would reasonably be considered an economic improvement. So what should have happened?

Taxes on bartering

Traders are technically required to include in gross income the fair market value of each item received less the value of the item given up (remember §61). So in the strictest definition, the paper clip Kyle found would have been a gain from found property. I highly doubt this de minimis “treasure” was reported, so no taxable gain means no basis, or zero value for purposes of establishing his “cost.” The subsequent trade for a pen, valued at $5, would simply be a taxable gain of $5.

There would be another gain for the trade up to the doorknob, less the value of the pen, and so on. The IRS will want each trade listed out on your tax return but, practically speaking for this article, we can just use the end result of the last item (house) minus the first item (paper clip) and we would yield the same net effect as adding up all of the gains and subtracting all of the costs.

We end up with a home and, therefore, a gain equal to the home’s appraised value of, let’s say, $100,000. The good news is that the trade is subject to all normal, incidental expenses of travelling and marketing these transactions. Simple, right?

Keep in mind all of the transactions in this fun story are personal property trades up to the trade for the home. There are complicating factors like trading for services and beneficial tax deferral options of trading like-kind real estate. If you are into bartering, check with your advisor so they can help make sure you get a good deal.