16 November '18 by Virtosu Art Gallery
Art and taxation for the global collector
The facts about the complex world of art taxation.
Can You Deduct Expenses Related to Purchasing or Selling Artwork?
Art appreciation goes beyond the aesthetic. If you truly appreciate art, you may spend significant amounts of money to support that passion. Purchasing art can include expenses for transportation, storage, display, and insurance, as well as fees for appraisals, conservation, and restoration. Conscientious stewards of financial resources look for ways to offset such expenses with tax rules. Fortunately for art lovers, there are some federal tax deductions that apply to art purchases. The types of deductions available depend on whether the Internal Revenue Service (IRS) classifies you as an artist, dealer, investor or collector. How the IRS classifies your interest and intentions determines whether you can deduct expenses related to producing, acquiring, managing and selling works of art.
What's Art to You?
In general, artists, dealers, and investors can claim any expenses related to creating, acquiring, preserving or transporting art if they are incurred as normal and ordinary business expenses, or if they are incurred in the production of income. While collectors are not able to take these types of deductions, they do get tax benefits when selling or giving away their collections.
Here's how the IRS defines each group:
This category is straightforward and describes the people who create works of art. Tax rules are not especially favorable toward artists. There is no artist resale right in the U.S.***
This classification is intended for people who engage in the business of dealing with art. The IRS determines this status on an individual basis, considering things like sales activity and efforts and intentions upon acquiring a piece of art. To be classified as a dealer, you must demonstrate that your interest in art is not just a hobby, because expenses and losses associated with a hobby are not tax deductible.
Like dealers, investors must show that their interest in art is more than a hobby. To be classified as an investor, an individual must show that art is collected primarily for investment purposes. To determine this status, the IRS will consider the purpose for which the piece was acquired, the length of time of possession, the investor's other business interests and the use of the proceeds from the sale of each work. To be an investor, an individual must sell, or be willing to sell, a piece of art for a profit. The IRS has denied many individuals investor status because they could not document that they ever sold a piece from their collection.
Most art purchasers are classified in this category. Collectors are those who appreciate art and accumulate it for personal enjoyment. While expenses for acquiring and maintaining art are not deductible for collectors, favorable tax treatment often can be received when selling or giving collections away. In the United States, there are a number of laws in place that encourage patronage of the arts, with tax deductions for individuals and organizations that donate artworks and cultural goods to foundations and nonprofit institutions. Generally, tax deductions for donations to charitable organizations vary between 20% and 50% of their value, with donations to cultural institutions resulting in a deduction of 30%.
How Much Might You Pay in Taxes?
Capital gains or income tax:
Capital gains tax, the tax paid on income generated by the sale of assets whose value has risen since purchase, is applicable to artworks across the U.S. provided that more than a year has passed between the purchase and resale of an artwork. When resale occurs within a year of the original purchase, any income gained is subject to normal income tax, which can reach 39.6% depending on annual income. If a work is sold more than a year after its purchase, however, sellers can choose either to pay capital gains tax on the income from that sale or to class it along with their other income and pay the appropriate percentage depending on their tax bracket. For almost any high-income individual (depending on their marital status and living situation) the more sensible financial choice is to opt for the capital gains rate of up to 28%.
Although artists, dealers, and investors can deduct business expenses related to producing and selling artworks, they do pay taxes on the sales of their art. The art sold by artists and dealers is considered inventory, which means sales are taxed generally at rates of up to the highest ordinary income tax rate, which is currently 39.6%.
Sales and use tax in the U.S. ranges from 0–8.875% Residents of Oregon, Montana, New Hampshire, and Delaware are not required to pay any sales tax whatsoever, while the unfortunate art lovers of New York City must pay 8.875% sales tax, the highest figure anywhere in the country.
When investors sell works of art, they are acquiring gains on their investments, similar to selling stock for a profit. As such, those sales are subject to the capital gains tax rate, which is 20% for taxpayers in the highest tax bracket. The long-term capital gain rate for collectibles, which may apply to both investors and collectors, is 28%. In addition, the Patient Protection and Affordable Care Act of 2010 added a 3.8% surtax on net investment income, which includes collectibles, for certain high-income investors and collectors. Therefore, investors and collectors in the highest income tax bracket could pay a tax of up to 31.8% on the sale of collectibles.
While in the United States and Europe imported goods are not subject to any customs duties, those taking works into China may be in for a nasty shock since the country imposes high import duties, which vary according to the country of origin. Ranging from 0% in the country’s free ports up to a staggering 50%, the high rates of taxation have no doubt hindered the development of the Chinese art market.
Successions and donations are subject to federal taxation
In the U.S., artworks given as gifts or passed down via inheritance are subject to gift or inheritance taxes above a certain threshold. Over their lifetime or at death, each individual may pass on or donate items or cash up to a combined value of $5,250,000. For example, an individual who gives gifts amounting to a value of $1,000,000 may pass on gifts with a combined value of $4,250,000 at death without being subject to inheritance tax. Additionally, gifts to a single individual in any given calendar year amounting to a combined value exceeding $14,000 are subject to gift tax. A progressive tax ranging from 18–40% applies to gifts and inheritance, with gifts or inheritance over $500,000 subject to the highest percentage.
Though there are certain federal laws applying to the trade, import, and export of artworks, there are also state-specific laws and regulations, making some more favorable destinations for trade than others. One such example is the state of Louisiana, in which all sales of one-of-a-kind artworks, within the boundaries of a certified Cultural District, are completely exempt from state and local tax.
Recent years have seen a number of new free zones (also known as freeports) springing up around the world. Art dealers, auction houses, and collectors have been among the first to jump on the tax-free bandwagon. Free zones are physically limited regions with favorable conditions for trade, allowing goods to be bought and sold without having to pay VAT or customs duties. Though the zones vary in the specific exemptions they provide, a typical Freeport includes a warehouse where goods are stored during sales and transactions. The arrival of several new freeports in China and Southeast Asia has provided a boost to the countries’ art markets, saving buyers from otherwise high taxes.
Make Sure You Understand the Whole Picture
Rather than assuming you'll be able to write-off the money you spend on art, take the time to figure out how your interest in art will be classified. By understanding the nuances associated with acquiring art, you can make better, more informed spending decisions.
*** There is no artist resale right in the U.S. Introduced as a means of protecting the interests of artists, the artist resale right has become a controversial subject for many across the art trade. In a number of countries and jurisdictions around the world, living (and, in some cases, recently deceased) artists are entitled to a percentage share of the sum paid for an original artwork when it is resold, usually on the condition that the artwork is above a certain value. The Resale Rights Directive, which was implemented across the European Union in 2006, requires that artists receive a 4% share of the sale value of works sold for under €50,000, with the percentage decreasing as the sale price increases above that mark. The highest sum that can be paid to an artist upon the resale of a work is €12,500, which applies to all works sold for more than €2,000,000. Artists from the U.S. are out of luck, however, as there is currently no artist resale right in place in any state. Nonetheless, there may be a glimmer of hope for the starving artists of California. Though the state’s artist resale right law was repealed in May 2012, having been declared unconstitutional, a draft for a new law is currently under consideration.