Collecting Taxes

WHEN A FRIEND TOLD me about his newfound interest in buying and selling sports trading cards, it reminded me of the joy that collecting brought me in my childhood. And when he asked me to explain the relevant taxation, it got me thinking: The core of the tax code is more logical than we give it credit for. It’s the ever-changing details that make it squirrelly.

If you buy and sell collectibles—whether it be sports cards, coins or antiques—the tax code assigns your activity to one of three tracks:

• Hobby
• Investment
• Business

What factors determine the tax track you should follow? It’s a question worth considering, but don’t overcomplicate it. Instead, try some simple self-reflection. Why are you engaging in the activity? Hobbyists are doing it for fun, investors are holding assets for appreciation and businesses are spending money to make money.

As a kid, I couldn’t get enough of sports trading cards and memorabilia, including Starting Lineup figures, autographs and pennants. Next to playing sports, nothing brought me more hours of fun.

Sure, I was intrigued by the possibility that these things might be worth something someday, but that wasn’t why I did it. I collected because it made me feel like I had VIP access to the players I looked up to—like I belonged to an exclusive club. I knew that, even if I never made a dime from selling my treasures, it would make no difference to me.

In other words, I was a hobbyist. But even hobbyists occasionally decide to part with a prized possession for the right price. This gain—like any realized gain in the tax code—is taxable income.

I remember a handful of times when I sold a card for what felt like a fortune. Those sales were taxable capital gains, but I never had enough income in one year to trigger an income tax filing requirement. I think $200 was my record sale. That’s typical for hobbyists’ gains: They’re usually small and infrequent.

But while their gains are taxable, hobbyists’ losses aren’t deductible, and I’m fine with that. From the government’s perspective, an allowed tax deduction is an expense. I don’t want Congress spending tax dollars to subsidize hobbies—not mine or anyone else’s.

Skip over to the next track—investment—and you’ll find that investors have the same capital gains treatment as hobbyists. But unlike them, investors can deduct capital losses. How can you prove that an activity is an investment instead of a hobby? If you had the foresight to keep adequate records to supply your tax cost basis to support a capital loss, that’s a good sign that financial appreciation was your motive, and hence you’re an investor rather than a hobbyist.

But please don’t misunderstand: A regular investor is willing to sell at a loss for specific profit-motivated reasons. For example, he or she might want to free up capital for a better financial opportunity, or to rebalance a portfolio’s asset allocation. But if you’re just offloading your personal stuff, you probably aren’t creating capital losses, even if you have pristine records. No, in that case, you’re more likely a hobbyist who’s decluttering.

Think about it: Do we really want the tax system turning yard sales into tax-loss harvesting opportunities? I don’t. If you want a tax break for cleaning out your closet, that’s what the noncash charitable deduction is for. You can donate to a charitable thrift store, like AMVETS, and create a deduction for the fair market value—the price the thrift store might charge for your things.

I still enjoy reminiscing over my old collection from time to time. Even though I’ve been a hobbyist, there’s no reason why I couldn’t try my hand as a collectibles investor today—now that I have more capital to work with than I did as a kid.

Maybe I’ll reallocate a portion of my investment portfolio and buy a few special cards for their appreciation potential. But what if I then spot an even better card, one that I just know is poised to shoot the moon? Maybe I would sell some of my investment cards to free up the capital to make the new investment, perhaps doing so at a loss. A capital loss supported by good records and reasonable facts would be pretty hard to argue against.

The third track—business—shifts to an entirely different tax regime. No more capital gains or losses. Sales proceeds become revenue, cards become inventory, and every business-related expense becomes deductible in the determination of net taxable business income.

My old card shop hangouts were easy to spot. They had a sign, a front door and people standing behind a glass display case, eager to swap stories about rookie cards and complete sets. By contrast, today a collectibles business might look like a guy with a computer—like my friend.

This is the tax track his collectibles activity took. He was implementing a plan—researching the market, locating undervalued cards he could buy, and reselling them for a profit. He was starting a collectibles business.

Now for the squirrelly details.

Collectors incur expenses like storage supplies, grading services and subscriptions. In the past, hobbyists could deduct these, but only up to the amount of hobby income. Investors could deduct them regardless of investment income. And both got the benefit only if they itemized instead of taking the standard deduction. Even then, the amount of the deduction had to exceed another hurdle to make a difference—2% of adjusted gross income. But just to complicate things further, the law changed starting in 2018, and this deduction no longer exists, at least through 2025.

There’s a separate long-term capital gains rate for collectibles of 28%. That’s not as favorable as the regular long-term capital gains rates of 0%, 15% or 20%, depending on your tax bracket. But unlike standard long-term capital gains rates, the 28% collectibles rate is a cap. If your marginal, ordinary tax rate is less than 28%, then that’s also the rate you pay on long-term sales of collectibles. This is an often-misunderstood nuance.

And of course, if you’re a business, there’s a host of other tax considerations—many of them influenced by factors such as your choice of business entity, whether you have employees and your home state.

These squirrelly details are the bane of accountants—but also their job security. You’ll know you’ve found a good one when you’re guided with the kind of healthy tax thinking that maps the economic reality of your activity to the principles of the tax code, and prepares you to make informed decisions on future activities.

This article originally appeared on HumbleDollar.com