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For these reasons, art investments are becoming increasingly more popular.
But did you know that art is taxed differently than other assets?
Art is classified by the IRS as an alternative investment and is thus treated differently when tax season comes.
So, exactly how are art investments taxed? What qualifies as an art investment? And what qualifies an individual as an art investor rather than an art collector?
In this article, we explore those questions and more. Let’s dive in!
Table of Contents
How Are Art Investments Taxed?
In a general sense, an individual owes taxes on art that they sell for a gain.
Like other investments, such as real estate and stocks, art is subject to capital gains tax.
However, it’s not quite that simple.
The amount you owe, and whether or not you owe, depends on a few definitions. First, let’s review how the IRS looks at art.
What Is An Art Investment?
The IRS classifies collectibles like art, coins, and stamps as alternative investments.
The term alternative investments covers a wide variety of investments that can even include things like alcohol, rugs, or antique furniture.
A collectible is something that has intrinsic value. Oftentimes this intrinsic value can increase over time due to an item’s rarity.
A piece of art that is displayed in the home for personal use will not be eligible for capital losses should you sell it in the future.
Short vs Long Term Capital Gains Tax
Art, as is also the case with stocks, real estate, and other investments, are subject to capital gains tax. The tax owed depends on the length of time the asset was held.
- Long term capital gains refer to an investment that is held for more than a year.
- Short term capital gains refer to an investment that is held for less than a year.
The time period generally begins the day after the asset is acquired.
Art sold after being held for more than a year is capped at a rate of 28%.
This is quite a bit higher than long term capital gains tax on most other assets. Collectibles have a considerably higher tax rate for long term capital gains as the government does not incentivize investors buying and selling these assets. Unlike many other assets, art transactions do not typically stimulate the economy.
Art sold prior to one year is subject to short term capital gains and is taxed as ordinary income.
Depending on your adjusted gross income, you could actually pay less in short term capital gains tax vs long term when selling art.
3.8% Net Investment Income Tax
In addition to the capital gains tax, you could be subject to an additional 3.8% net investment income tax.
This tax is paid by those who have net investment income plus have adjusted gross income that meet the following thresholds:
- Married Filing Jointly: $250,000
- Married Filing Separately: $125,000
- Single: $200,000
- Head of Household (with qualifying person): $200,000
- Qualifying widow(er) with dependent child: $250,000
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How To Calculate Art Capital Gains Tax
Capital gains are simple in theory – the gains (or losses) are the difference in the amount that you sold the asset and the amount that you acquired the asset.
The amount that you acquired the asset for is called the cost basis. Most often, the cost basis is simply the amount you paid for the asset. However, it can also include any brokerage fees, commissions, transportation fees, and other transaction costs.
If you inherited the piece of work, then the cost basis is generally the appraised or market value of the piece.
Keep in mind, the higher the cost basis, the less is owed in capital gains.
Let’s say you purchased a painting for $150,000 and held onto it for 10 years.
At that point, you had it appraised at a cost of $5,000 – but found out it was now worth $300,000.
Your cost basis would be $150,000 + $5,000 + any other costs incurred to store/transport/sell the piece.
In this case, the cost basis is $155,000.
Assuming you sold the painting at auction, you’d expect to pay a 15 to 24% fee to sell the artwork. If it sold for $310,000 and you paid a fee of 20% to the auction house, your proceeds would be $248,000.
You would then subtract your cost basis, or $155,000 from this figure, to determine your profit.
In this case, your profit would be $93,000 and that is the amount you would pay taxes on.
Your capital gains taxes would be a maximum of 28% of that figure, or $26,040, since you held onto the artwork for longer than one year.
Suppose you inherit a piece of artwork from a family member or friend.
After holding onto it for over a year, you decide to sell the piece. You choose to sell the piece through an online auction house like Sotheby’s. The piece is appraised for $20,000. At the auction, you actually sell the piece for $22,000.
- Because this was an inherited piece of artwork, the cost basis is $20,000, or the appraised amount or current market value.
- Thus the capital gains in this example work out to $2,000 (sold price – cost basis).
Because the piece was held for greater than a year, the taxes owed will be the capital gains of $2,000 multiplied by a maximum of 28%, or $560.
However, you would end up paying a fee to the auction house that would most likely eliminate your tax bill entirely.
How Do Capital Losses Work?
A capital loss occurs when you sell an asset for less than you acquired it for.
However, you are not able to claim a capital loss unless the asset was purchased for an investment purpose only.
Capital losses can be used to reduce your overall taxes owed in a given year. Suppose you sell two pieces of artwork in the same year. One has capital gains of $5,000, and the other has capital losses of $4,000.
The capital losses of $4,000 reduce the $5,000 gain to just $1,000. Thus, you would be responsible to pay taxes on the $1,000 net capital gains.
If you do not have any capital gains to reduce, then you can use capital losses to reduce your ordinary income up to $3,000 per year.
What Are The Tax Implications With Donated Artwork?
Donating artwork is a way to potentially reduce you overall tax bill. However, there are a few important things to consider when donating art.
- First, the IRS requires an appraisal on any charitable donation of greater than $5,000. This appraisal must be attached to your tax return and be readily available over the next five years if requested.
- Second, in order to gain a current year income tax deduction, you must itemize your deductions.
- Third, not all charitable donations are created equal. The IRS has a “related use” rule. If you donate a piece of art to a charity that will not actually display the artwork, then your deduction will be the lessor of the cost basis or current market value.
- Fourth, the IRS does not grant you a deduction on your taxes for art donated that was held for less than a year.
How To Defer Capital Gains Taxes With Artwork?
In years past, art investors were able to sell a piece of art and immediately put the proceeds into another art investment.
Section 1031 allowed investors to do this and defer capital gains taxes. While this did not eliminate taxes owed, it did allow investors the ability to trade art investments without taxes owed each time they sold.
However, the Tax Cuts and Jobs Act of 2017 removed this “like-kind” exchange for artwork. Investors are still able to perform this tax deferment with real property, but artwork is now excluded.
Though another opportunity exists to defer taxes owed. This is through an investment in opportunity zones.
If profits from the sale of an art investment are invested in an opportunity zone, then investors could realize a reduction of the capital gains tax from the sale of the artwork by 15%. The investment in the opportunity zone must be held for at least 7 years.
However, if held for more than 10 years, then the investor will not be responsible for taxes on any profits realized from the opportunity zone investment.
One critical note here to recognize is that art investors are able to reduce their tax bill by moving investments out of artwork.
Art Investment Taxes: Final Thoughts
Like any investment, art investments carry certain tax implications.
Unfortunately, art investments have a higher long term capital gains tax than most assets. For art, the long term capital gains tax rate is 28%.
On the other hand, short term capital gains are taxed at your ordinary income tax. Thus, you could pay less in short term capital gains vs long term.
Capital gains depend on your cost basis. The cost basis is typically what you paid to acquire a piece of art. However, in some instances, such as with inherited art or when making a charitable donation, the piece must be appraised to determine the fair market value.
In year past, investors were able to defer taxes through a like-kind exchange under section 1031. This meant exchanging one art investment for another. However, under the Tax Cuts and Jobs Act of 2017, this provision changed to apply to real property only.