How Recent Changes to Tax Law Could Impact Collectors
Andy Warhol showing his artistry circa 1980s in New York City. Photo by Robin Platzer. Image via Getty Images.
In March, the IRS extended the deadline to file taxes in the United States to July 15, 2020, in response to the COVID-19 pandemic. As the new filing date approaches, we outline the most important recent changes to tax legislation affecting art collectors today—from a tax overhaul in 2017 to new legislation in response to COVID-19—and how to navigate them.
The end of “like-kind” exchanges
Perhaps the biggest shift in tax policy for art collectors in recent years came in 2017, with the elimination of the “like-kind” exchange for the category of art. This exchange allowed a collector to defer capital gains tax, provided they put the profits from the purchase toward another asset of the same kind—in this case, art. The Tax Cuts and Jobs Act of 2017 curtailed the use of the like-kind exchange to real estate transactions. And although many predicted that the elimination of the like-kind exchange for art would harm the art market, this bleak prediction doesn’t seem to have panned out.
“We did expect to see a downtick in the number of sales because of the elimination of like kind exchanges for artwork, but we really didn’t see, at least initially, a downtick in sales activity,” said Sarah Verano, associate lawyer at Withers.
The establishment of the opportunity zone program in 2017 created a new way to defer capital gains tax. The program allows investors to defer capital gains tax on investments, provided they invest that money in certain economically distressed areas called “opportunity zones.” “If you invest into an opportunity zone, it allows for the elimination, potentially, of capital gains [tax],” said John E. Lee, a certified public accountant and an advisor at business management firm ML Management.
And although some viewed the opportunity zone program as a potential replacement for the like-kind exchange, both Verano and Lee see the program as appealing more strongly to real estate investors than art collectors, due to the large amount of regulation surrounding opportunity zones. Lee did note that many of the larger investment firms—like Morgan Stanley or Goldman Sachs—have funds you can buy into that count as opportunity zones, making it easier for some taxpayers to take advantage of the program.
But with the art market slowing down due to the pandemic, Verano suggested Congress might consider bringing like-kind exchanges back to stimulate the economy. “It certainly might be an interesting tactic,” she said.
Sales tax obligations
Verano also pointed to the result of the Supreme Court case South Dakota v. Wayfair et al. as a major change impacting art collectors. The 2018 case decided that states are allowed to enact “economic nexus” laws, meaning that businesses without a physical presence in a state would still be required to pay sales tax there if they conduct sales in that state.
For the art market, this means galleries and auction houses that ship art out of state may have to pay sales tax in that state, provided it had enacted an economic nexus law and the sale itself crossed a certain financial threshold.
“Say you had a gallery located in New York and you were shipping artwork to a collector in California. Unless the gallery had some kind of physical presence in that state, the gallery [previously] may have had no obligation to collect California sales tax,” Verano said. “But now the gallery might.”
Passing art on
The Tax Cuts and Jobs Act of 2017 also temporarily doubled the lifetime exemption limit—or the amount an individual is allowed to pass on during their lifetime without needing to pay estate tax—until 2025. In 2020, the exemption is $11.58 million for an individual and $23.16 million for married couples, and changes slightly each year due to inflation.
“This is the highest it’s ever been in my career, it would pay for people to take advantage of it if they can,” Lee said.
By passing on art to the next generation now, wealthy individuals can avoid paying estate taxes on gifts once the exemption limit drops back down to $5 million for an individual, adjusted for inflation, in 2026.
Verano also highlighted the importance of having a procedure in place when deciding who inherits a collection after your death. “From a very practical standpoint, when you pass on a collection of art to your family, you need to think about how the artwork will be distributed among members of your family and how they’re going to manage the collection,” she said.
Questions like who gets which pieces of art, whether the collection should stay together or be split up, and when and if the collection is to be sold altogether must be clearly answered and documented to limit disputes among family and friends.
The impact of COVID-19
More recently, the Coronavirus Aid, Relief, and Economic Security (CARES) Act has made it easier for taxpayers to donate to nonprofits, providing a unique opportunity for collectors to support art institutions. Instead of having their donations capped at 50 or 60 percent, an individual can now donate up to 100 percent of their adjusted gross income—or the amount of money a taxpayer makes in a year—to a nonprofit.
“So someone who makes, say, $10 million and wants to give away $10 million can give away $10 million, and potentially eliminate all of their taxable income if they do it in a certain way and a certain manner,” said Lee.
Individuals who take the standard deduction can also donate up to $300 to a public charity and receive an “above the line” charitable deduction for that amount and deduct that total from their adjusted gross income.
“The idea is to encourage people to give a lot of money this year,” Verano said, noting that she had already seen some interest in the new provision. She pointed out that these provisions only apply to deductions in 2020, meaning they’re not relevant for those who haven’t yet filed their 2019 taxes.
Verano also warned that states are likely to continue or even step up their enforcement of sales tax collection during the pandemic. Both the auction house or gallery and the purchaser of an artwork are obligated to make sure sales tax is paid in the correct state jurisdiction.
She outlined a scenario where a collector may have purchased a painting from a gallery in New York and planned to have the dealer ship it to their home in California, but then ended up storing the work at the New York gallery for the time being due to the pandemic. If that work sat in New York for long enough, the state’s tax authorities may say that the artwork was “delivered” in New York and that New York sales tax needs to be paid on that work. If COVID-19 has disrupted a collector’s plans for buying or shipping art, that individual should refer to a tax professional to see where they may be required to pay sales tax.
“At some point, New York might consider that artwork to have been delivered to New York, so you might need to think about paying New York sales tax instead of California sales tax,” she said.