There are many old ideas getting recycled these days, and we are going to be writing about a lot of them here, as we look at them from a financial planning perspective.  Some of them have definite financial planning benefits, and others offer little net return to us in this context, but have gained in popularity either through misconception, of through some creative skirting of various rules.  Today we are going to take on the subject of barter.  I have occasionally spoken to small and medium sized business owners that engage in barter transactions in the course of their business.  With the growth of the internet as a communication tool, barter has also been making a comeback, almost as an extension of the idea of recycling.   There is evidently a fast-growing barter subculture among twenty- and thirty-somethings.

In case you don’t know, Barter is simply the exchange of goods and services without using currency. Just trading one thing for another. It is not a fundamentally different transaction than the transaction that we are used to in the developed world.  We should spend a few hundred words on this, to make the point, if you are really comfortable with this idea skip ahead to the end of this sidebar. 

Bartering in a nutshell

If my neighbor and I breed poultry, and I have an extra chicken and my neighbor has an extra duck, assuming we both eat poultry, and he wants to eat chicken, and I want to eat duck, we can trade and add a little variety to our diet.  In this case, we decided the duck and chicken had equal value, presumably because there is nobody else around to buy them, because we are hypothetically in the middle of nowhere.  If my neighbor really wants chicken, and I equally want duck, we have a trade.  If he figures his duck is worth more, he holds out for five pounds of turnips on top of the chicken.  In a “limited bidder” economy, like one that our nomadic hunter-gatherer forbears probably had, this is generally a sufficient system, but not efficient at figuring out what something is really worth, because you don’t have something called “market depth”.  Market depth increases as the number of possible buyers increases.  The larger (or “deeper”) the pool of buyers, the more likely you are to have a realistic estimate of what the duck or chicken is worth to the group, if you repeat the transaction a bunch of times.  It is akin to looking at election poll numbers, where poll of ten people is less representative than a poll of ten thousand people.   There are large scale bartering systems, but we will be looking at them in the next episode.  Today we are going to look at smaller scale bartering systems.  These are less efficient.

If we add currency in the middle, not much changes except the granularity of the pricing, and the number of possible bidders (assuming we are no longer isolated).  We could try to set a value on the chicken and duck in dollar terms, which in this case would equate to roughly the same equivalent value as we started with, because the sellers have a value in mind.  Let’s assume my neighbor and I both figure our birds are worth twenty dollars.  If I put the currency in the middle, I can accept twenty dollars from anybody, and so can he.  By creating more “bidders” for my chicken and his duck, we can arrive at a more granular price.  I find out that most people only want to pay me fifteen dollars for my chicken, and he discovers that he can get twenty five dollars and thirty cents for his duck. (This obviously a vast simplification, but it is a necessary one so that we can get down to the subject at hand.  We will probably write more about this in the future, as we have a few planned articles discussing market equilibrium, or in game theory, variants of the “Nash Equilibrium.”   Also, the value we place on what we have as compared to what we want has a fair amount of elasticity, which is yet another whole topic to tackle.) 

The point is that this is essentially the same transaction, but the usual medium of exchange for us is the currency as a store of the value of the chicken and turnips which I sold to a third party, and then transfer to my neighbor in exchange for his duck.   Usually the way this works in practice is that you put in a certain amount of expertise (or labor) at work, which is worth some amount of value, and you exchange that value for a duck (to use our example earlier), and other things, by getting money in exchange for work and then trading the money for the aforementioned duck.  The money you use simply stands in place of your side of the transaction, essentially keeping score of how much the value of your side of the barter has been reckoned at. 

If you are not particular about reliably getting the most “efficient” price, barter is a fine way to go, assuming you have things to trade.  If you look on www.craigslist.org you will often find barter offers.  The classic form is something like this: “1979 Eldorado in average condition, 200k miles, original owner, needs paint.  Willing to trade for a nice ten-speed bike, a shih-tzu puppy and the collected works of Neil Sedaka on 33 rpm vinyl.”  Okay, it may not really be that obscure all the time, but you can probably see the point that barter can be a bit more complicated as a way to get something that you are looking for.  Sometimes people are more straightforward, and just say something akin to “Willing to consider trades of other items, such as motorcycles, motor homes, appliances or similar.”  Here is an excerpt from an actual barter offer: 

“…nice washers and dryers for bartering for equal or greater value.  i (sic) am interested in item such as electronic, jewelry, lawn motor, generators, etc. just let me know what you have. They are all in good condition and in good working order…” (Source: craigslist**Identity protected**)

This gave me an idea for an experiment (which we will come back to at the end of this two part series), but in the meanwhile, we need to think about why (or how) this could be useful, and why it seems to be making a comeback in certain circles.  Then we can look at whether it makes sense in those contexts, and what the implications are.

Community Barter

The most common groups of barterers I encountered in my research are what I call “community barterers.”  These are people who congregate around a trade or pastime and often have interchangeable (and exchangeable) needs.    Whether the group in question are breeders of Bengal Cats, homesteaders, sailboat owners, building contractors, or bicycle enthusiasts, what organizes them is a common interest in something, or the common practice of some vocation or pastime.  Sometimes this group is organized in other ways, a group of tradesmen in an industrial business block are organized geographically, and because they are small business owners, with similar interests, but different trades.   The definition of community changes, but the concept is the same.  Community exchanges are generally of the type that either appear on group message boards (physical or virtual) or are passed through word of mouth.  People put out the word that they are looking for something, and somebody that has the item or service offers to provide it (or the reverse). 

In chatting with barterers from this group, it became clear to me that they had a preference for bartering over buying for a couple of reasons.  The first is that they consider barter to be a less costly means of getting things.   If they have their friend from the shop a few bays down in their industrial complex pave their driveway at home, in exchange for detailing their car twice, they feel that they got a bargain.  They look at the cost to them for the service performed in exchange, and compare it to the retail cost of the service they received for the purpose of the comparison.  It was almost universal.  This may not be the best way to think about it, as there are plenty of economic models that would cast doubt on this logic, but it was a common view.  Certainly there is an advantage in asset depreciation terms, most “use” assets depreciate almost immediately once you remove them from the retail store.   Trading a depreciated asset for another allows for no second ride down on another depreciated item purchased new at retail prices.  It has no particular advantage over purchasing the item used in depreciation terms, unless the counter party is more interested in the trade than you are, wherein you might get a better bargain. 

The second preference expressed was a bit more mixed in its perceived value.  Often the delivery of the good or service was on a flexible schedule, which was a positive from the standpoint of delivery, but a negative from the recipient’s point of view.  Scheduling barter services or the delivery of goods around your own convenience is nice, but having to wait for something until it is convenient for your counter-party is a bit of a grind.  In today’s on-demand economy, people are often unhappy with having to wait, and that detracts from the perceived value of the trade, while delivering later enhances the value of the trade, so it changes the dynamic in interesting ways.  

The third reason it was preferred was the one that was the most interesting.  The perception was that the total value received was enhanced by the avoidance of all the taxes.  This is a VERY slippery slope.   People in these community barter arrangements rarely (based on my discussions, it was probably never) paid taxes on any of the value received.  That means no sales taxes, income taxes or capital gain taxes.  Some of them were surprised to learn that they were supposed to have declared this amount.

I am not an accountant, and do not give either legal or tax advice.  I will simply point out that the IRS does have rules about barter, and about the reporting of barter transactions.   I grant that there are some areas that are a bit gray, but the rules have been pretty well established since the 1970s.  For an overview of the rules, you can check out the IRS’ Tax topics--Topic 420.    Basically it breaks down this way—when you exchange services as part of a barter (at least if you are a business) you are expected to give the recipient a 1099-B with the total value of the service, which is includable as income just as if it was an exchange of currency.  There might still be an advantage here, because the services provided in return are deductible as expenses, so that should theoretically be advantageous, but you should evaluate that with your accountant to be sure, and to be sure you do it right. 

When I spoke to the community barterers that were businesses about this, a few of them were aware of the tax rules and had their answers ready.  They claimed one of two exemptions from the requirement to issue 1099’s.  The first exemption was that the good or service was a gift, not a barter.  If the other person responded by giving a gift as well…that was their prerogative.  In the assumption that most of the exchanges were of less than the gifting limit, on the surface this seems like a plausible excuse, but really who are we kidding?  The IRS is well aware that certain transactions, even those that are a bit informal have a quid-pro-quo nature.  The IRS ruled on this back in the 1950’s and has probably made similar rulings since.  In The Commissioner of the Internal Revenue Service vs. Dubenstein, they found that a gift that was fundamentally “earned” through past services (even good deeds) or in promise of future services (or exchange) was not a gift at all, but income (http://theorderoftime.com/politics/cemetery/stout/h/pbb-22.htm).  Basically, the IRS will look at the intent of the deal. 

Another “exemption” that was claimed by some folks was directly from the IRS Tax topic: “[Barter] does not include arrangements that provide solely for the informal exchange of similar services on a noncommercial basis.”  Things get even murkier when the people engaged in the transaction are not business but individuals.  Individuals seemingly do not get the advantage of the offsetting tax deduction we discussed earlier.  If the driveway blacktopping for car-detailing trade occurred between individuals, it seems unlikely that either would be able to take tax deductions for their work, and likely that the IRS would want a 1099-B, so that the receipt of the work (a phantom income) would be effectively income taxable. Most of the guidance available from the IRS seems targeted toward small businesses and “Barter Clubs (aka Barter Exchanges—which we will talk about next time), so the guidance for individuals is a bit murky.  The lack of commercial exchange appears to be a valid exemption, as the IRS is not interested in a gardener bartering tomato stakes for a wheelbarrow.  As I said, I am not an accountant, but it appears that the service put this language in place to show where their enforcement would draw the line.  I recommend anyone that does these kinds of exchanges speak with their accountant about the matter.   The crux of this supposed exemption is that people feel like they are unlikely to get caught.  Everything I have read indicates that the parties are supposed to issue 1099-B’s for the exchange, but if none are issued, the participants figure that they are unlikely to be found out.  Given that in recent years the IRS has put a spotlight back on bartering, including setting up the Bartering Tax Center, these hopes may fall well short of reality, either now or in the future.   In short, barter can end up being fairly messy.  There is a great example of how messy it can get in an interesting article in Forbes, written by Robert W. Wood back in 2009.  It is called “Do you Barter?  The IRS wants Its Cut.”  It is worth a read if you are thinking about barter as a way to get the taxing agencies out of your life.   Think about trading appreciated items triggering potentially income and capital gains implications…I think you will find that the solution is not as great as it seems at first glance.  In the event of an audit, the IRS examiners will be looking for signs that you engage in barter transactions, and if they find them…the situation can get complicated indeed.

Follow up posts coming soon:

• An evaluation of Barter Clubs and Exchanges, how they work, why people use them, what advantages and disadvantages they offer

• Some obscure barter issues considered, such as barter credit donation, tax-free exchanges of bartered goods, and other fun issues.

• A bartering experiment, to sort out the tax and economic consequences to an individual real-time

• Possible guest post on this topic…