Wait, are both parties responsible for paying taxes in this case? In the normal case the party receiving payment for services rendered is the one that pays income taxes. Here both are providing and receiving a service at the same time.

If the barter is for services (I mow your lawn if you do my taxes), then yes, both parties would owe income tax on the fair market value of the services -- it would be the same as if they had paid each other the same amount in cash.

If the barter is an exchange of goods for services (I'll do your taxes in return for 10 dozen eggs from your farm), then the party that received the goods in exchange for their services owes income tax on the fair market value of the service provided. The party that provided the goods would owe income tax on the capital gain of the goods (fair market value minus the cost paid, or basis).

If both parties are exchanging goods, then it gets more complicated. In some cases (I trade you the deed for my apartment in the city for the deed for your beach house), the IRS deems it a "like-kind exchange", which is NOT a taxable event -- the basis of the old items carries over to the new properties. However, if I exchange my apartment for your car, then it's not a like-kind exchange, because the items exchanged are not of like kind (makes sense?), and both parties pay capital gains (or can claim a loss) vs. the fair market value of the exchange.

To add to the fun, one can do a delayed like-kind exchange by storing the proceeds with a "qualified intermediary", a form of escrow agent. This is often done with real estate, since it means that the counterparties don't have to be willing to swap deeds. To give a specific example, I could sell my apartment in the city, deliver the proceeds to a qualified intermediary, and use them later to buy a beach house, and it would be treated as a tax-free exchange by the IRS (if the prices of the two properties are equal and some other criteria are met).

Excellent post overall, very helpful.

>> However, if I exchange my apartment for your car, then it's not a like-kind exchange, because the items exchanged are not of like kind (makes sense?), and both parties pay capital gains (or can claim a loss) vs. the fair market value of the exchange.

You probably can't claim a capital loss for a car as you can only claim it for things you hold for investment purposes. Since the car's depreciation is expected to be because of personal use you can't claim loss on it whereas if it were to increase for some reason (memorabilia) you'd have to pay gains.

Fair point, I'd have to be holding the car for investment purposes, or using it as a business asset, not using it for personal transport.

It's more complex than that because both parties have to report the dollar amounts of the goods/services in the barter exchange.

Whoever comes out on top has to report income, and whoever comes out on bottom has to report the expense.

Assuming the barter trade was even, the income and expense would cancel out thereby no taxes would be owed.

In barter exchanges, this is almost never the case, and is more suspicious when reported as such.

The whole point of barter is that the stuff traded by each side has roughly equivalent value to the traders.

Seems like the tax rules outlaw pure barter and make you use dollars in your transaction whether you want to or not.

I was pretty sure the point of barter was that both sides realized a gain. That's the concept of "gains from trade".

I mention this because you specifically call out "equivalent value to the traders".

Gains from trade are theoretical numbers, based on the shapes of the supply and demand curves. As long as those numbers are positive, trade still happens. When zero, the traders are indifferent to the trade. So when things like monopoly pricing, taxes, and price discrimination com into play, a certain quantity of trade will simply not happen.

That value is not something you can tax directly. It's more like happiness than cash. In the barter, the traders walk away with the same value of goods, but greater happiness. I'm not sure what dollar value the IRS places on happiness, but based on their behavior, I'm pretty sure it is $0 per smile.

Therefore, neither trader in a normal barter should realize a taxable gain.

In barter, both parties believe that the value they walked away with is greater than the value they put into the deal. In principle, that's exactly what the IRS wants to tax. A currency system should generally preclude any barter by assigning reliable values to both parties' goods, such that the one whose stuff is assigned a higher monetary value by the market will be unwilling to make the trade, since they could do better by just selling their stuff and buying the other party's. (A raw trade could still happen where the market value of each party's offering is somewhere within the bid/ask spread of the other's.) But that's independent of what "barter" is. Barter is just trade unmediated by a currency. You can realize taxable gains through barter in just the same way that my uncle once paid his rent for a month by selling an art object he bought at a garage sale for under $100. Despite being mediated by cash, that was a highly uneven trade, and barter is no different.

In a happy coincidence for the IRS, assigning monetary values to everything makes it trivial to assign a value to the trade for the gaining party to pay tax on. Again, not relevant to what barter is.

Given that the IRS can operate under any rules that the government pleases itself to create, regardless of any connection to reality, I don't think anyone there even attempts to discern whether a given rule is actually generating revenue or just fruitlessly destroying commerce.

As you say, anyone with enough cash available would always prefer settling with two trades using money instead of one barter trade. So really, the barter tax is only levied on people who don't have the money to pay it and on tax avoiders. The tax avoiders find another loophole; the poor people remain screwed.

You can do pure barter, you just have to pay taxes on the transaction -- and those taxes must be paid in dollars.

This is part of what it means to be a national currency -- it's what the government accepts for payment of taxes.

Which is the point, the IRS doesn't want barter to be normalised because that would mean some people could claim barter and escape paying tax.