Art of the Deal: Tax Consequences of Collecting
2005 - Artistically minded taxpayers need to be knowledgeable
about the tax consequences of buying and selling paintings,
sculptures, and other works of art. The first step is to
determine if the taxpayer should be classified as a collector,
a dealer, or an investor.
According to the IRS, a collector buys art as a hobby. Thus,
an art asset is not for the purpose of making a profit on
sales, but primarily for the enjoyment of ownership. The
collector does not purchase art for resale, and therefore
pays state and local sales taxes. A collector who borrows
money to purchase a work of art cannot deduct the interest,
because it is classified as consumer interest. The only
benefit of collector status is that the collection is considered
a capital asset rather than inventory.
a collector donates art to a museum, the fair market value
of the deduction is identified as a charitable donation
and he files IRS Form 8283, Noncash Charitable Contributions,
with his personal tax return. This can be reversed under
audit, however, if the IRS learns that the collector purchased
and donated multiple copies of the same artwork. The taxpayer
would then be classified as a dealer, and the deduction
would be limited to the cost of the artwork.
usually donates an item that has appreciated substantially
in value. A common mistake is to accept a gift from the
artist who created the work. In this case, the valuation
is limited to the artist’s cost of materials, and
there is no consideration on the holding period or the appreciated
value of work. It is best to buy a work from the artist
and pay by check or obtain a dated receipt for any cash
purchases. The sale from an artist to a collector, regardless
of price, avoids the basis limitation of the artist’s
cost of materials.
A dealer engages in the business of selling art. A taxpayer
has the burden of proving she is a dealer in order to deduct
ordinary and necessary business expenses. Problems can arise
if dealer status is claimed by a part-time dealer who has
other sources of business income, in which case the IRS
could argue that the activity is only a hobby. Most private
art dealers are full-time, because closing a single transaction
may take weeks, months, or even years.
dealer status is difficult if all transactions are purchases.
Showing sales with appropriate gross profit percentages
is important, even if fixed costs and other operational
expenses create a loss on the financial statements. To help
prove dealer status, the individual can create a corporation,
establish a bank account, use business cards and office
stationery, participate in trade groups, and advertise in
industry magazines. A bona fide dealer obtains a sales-tax
resale certificate and remits sales tax collected from customers.
A dealer can donate art only at cost, not the fair market
value claimed by a collector.
An investor is an individual who puts money into a business,
real estate transaction, or other asset for the primary
purpose of producing income or profits. Establishing this
status for tax purposes is difficult because an art investor
obtains the benefits of both being a collector and being
a dealer. (See the Exhibit.)
An investor should have a more passive interest in the work
itself, and be primarily interested in the profit associated
with selling the art, rather than the enjoyment of a collector.
Most of an investor’s art is stored in locations other
than his home, or is on loan to museums. An investor may
well enjoy art, but must be willing to sell a work once
it has appreciated in value.
some advice on how to start collecting artwork and learn
more about appreciating art, see the Sidebar.
concern for anyone who owns art is qualifying for the lower
long-term capital gains tax on the sale of a work. Collectors
and investors are allowed the favorable tax treatment upon
holding the work for the proper period. Dealers and artists
are required to report the gain as ordinary income, regardless
of any holding period.
situation becomes more complicated when a dealer wants dual
status as an investor. If art is purchased at auction, then
sales tax should be paid and all accounting should be maintained
in a separate corporation and bank account. In good tax
planning, a dual-status dealer/investor will establish separate
insurance policies, storage facilities, and two different
accounts at an auction house as well. Segregating these
activities in efforts to prove the fair market valuation
taken on art donated to a charitable organization is important.
The status of a donee organization should be verified by
reviewing a recent edition of IRS Publication 78, Cumulative
List of Tax-Exempt Organizations, or obtaining a letter
from the IRS validating the donee’s status.
for Charitable Gifts
who donates an item or a group of similar items (e.g., photographs,
rare books, paintings) with fair market value of more than
$5,000 must obtain a qualified appraisal not more than 60
days prior to the donation date in order to claim a deduction.
The appraisal summary must be signed and dated by the appraiser,
and be included in the tax return.
appraisal report includes a complete description of the
work; the name of the artist; the approximate date created;
the cost and purchase date; a history of the item; its physical
condition; photographs of the artwork; the expected date
of contribution; the terms of any agreement for the donation;
the name, taxpayer identification, and qualifications of
the appraiser; the date of appraisal; and the work’s
fair market value, along with the valuation method used
(such as the income approach, the comparable-sales or market-data
approach, or the replacement-cost-less-depreciation approach).
The report should also include a statement indicating that
the appraisal was prepared for income or estate tax purposes,
and a description of the fee arrangement between the donor
and the appraiser. Failure to provide this documentation
within the tax return will lead to the disallowance of the
are recommended for art collections prior to acquisition,
selling, insuring, making a gift, filing an insurance claim,
claiming a casualty loss, or computing estate tax. Art appraisal
is subjective, especially when valuing a unique piece. A
qualified appraiser must perform appraisals on a regular
and independent basis. Anyone who intentionally falsifies
an appraisal summary is subject to civil penalties ranging
from $1,000 to $10,000, and the appraisal may be
Determination for the Value of Charitable Gifts
IRS may accept the valuation or choose to make its own determination
of the fair market value. It may hire an independent dealer
or scholar when the art may require an expert appraiser
with specialized skills, experience, and knowledge. The
IRS normally does not review or approve any valuations prior
to the actual filing of the return; however, the taxpayer
may request an advance determination procedure from the
IRS if an artwork has been appraised at more than $50,000.
request can be made only after the donation has been made,
and the application must be made early in the tax year so
that the approval is obtained prior to preparation and filing
of the return. The application fee is approximately $2,500
for the first three items and $250 for each additional item.
Art Advisory Panel
Art Advisory Panel is a group of 25 outside professionals
hired by the IRS to evaluate and challenge taxpayer valuations
of artwork in the $20,000-plus category. Panel members are
prominent dealers, museum directors, and curators. They
discuss each work and provide a conclusive fair market value
of an item. The taxpayer’s identity is not disclosed
to a panelist, but a prominent artwork is often identifiable
as being from a particular collection.
who has a conflict of interest on any level of a particular
matter must excuse himself from the conversations. Panel
meetings are closed to the public, but a summary report
is issued each year.
Broderick, CPA, is president of Broderick & Company,
CPA PC, in New York, N.Y. This article and sidebar were adapted
from two articles, “Art Appreciation” (September
2003) and “The Art of the Deal” (March 2003),
that previously appeared in the Investment Advisor (www.investmentadvisor.com).