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The sweeping tax reform bill that passed both houses of the United States Congress this week has the potential to reshape the top end of the art market.
The bill, which President Donald Trump is expected to sign into law, gives a break to the real estate industry, a sector that generates a large share of the world’s top art collectors in the world’s largest art market. But it also repeals a provision of the tax code, section 1031, that encouraged collectors to buy more art in order to defer taxes after selling a valuable work.
The break for the real estate industry puts more money in the hands of “some of the most voracious buyers of art,” said Doug Woodham, former president of Christie’s in the Americas and now an independent advisor, referring to commercial real estate developers such as the Toll Brothers and the Miami-based collector Martin Margulies. At the same time, Woodham noted, the withdrawal of the 1031 provision will likely have a dampening effect on consigning, although the magnitude of the impact is hard to discern, given the lack of hard data on its usage.
The provision affecting real estate investors was a last-minute change, put in reportedly to win the vote of Republican Senator Bob Corker of Tennessee, who had initially opposed the Senate’s version of the tax bill on the grounds that its projected net $1 trillion addition to the federal deficit is “fiscally irresponsible.” He reversed his position after Republican Senator Orrin Hatch of Utah “sculpted a provision letting LLC owners with few or no employees access the tax cuts, making their depreciable assets—such as real estate holdings—partially deductible, ” according to the International Business Times, which looked at how the provision benefited Corker, President Trump, and other senators. Before the provision was added, tax cuts were contingent on how much a business owner paid in wages, which was meant to tilt the benefits towards “job creators,” rather than simple rentiers.
Corker has significant real estate holdings which generated “between $1.2 million and $7 million of annual rental income,” and was accused of putting his personal interest ahead of his principled opposition to the bill, although he has said he eventually supported it to stand with the rest of his party. An analysis by the nonpartisan Tax Policy Center found that the new bill could provide “up to 10 times the amount of tax benefits to the real estate sector as the original Senate-passed bill,” according to the International Business Times.
By contrast, art businesses such as galleries and auction houses will not be one of the major beneficiaries of that provision, because it applies to only to depreciable assets, rather than assets held as inventory for sale, such as a painting or sculpture, said Micaela Saviano, Deloitte Tax LLP’s art and finance practice leader.
Still, dealers may benefit from increased demand. One in four of U.S. Trust’s clients come from the real estate sector, said Evan Beard, who heads its art-lending practice. An Artsy analysis of the industries that drive the art market found that 18% of the ARTnews top 200 collector list in 2016 have backgrounds in real estate and construction, up from 16% in 1996 (the ARTnews list is global, so some will not be affected by tax reform in the U.S.). The names of collectors in that industry are familiar to anyone who follows the market: Rubell, Braman, Pritzker, Bluhm, Minskoff, Brodsky.
“One of the great active, dynamic collector segments is real estate developers and professionals, so any time you have more disposable capital in their hands, that is stimulative for the art market,” said Beard.
But the bill also restricts the use of a tax loophole, known as a 1031 swap, to real estate transactions. Section 1031 of the tax code was originally designed to benefit the real estate industry and help support home-building and the housing market more broadly, by allowing the seller of an asset to defer taxes on any gains from the sale as long as she put the profits towards the purchase of another asset of the same kind, in what is called a “like-kind exchange.” The new tax bill curbs the use of this provision for “tangible,” or portable, assets such as art, limiting it to only real estate transactions.
Woodham said the provision was initially applied by commercial real estate developers to art purchases, since they knew of it from their real estate dealings. Then word spread, and more and more wealthy collectors started using it, providing what Woodham calls “fuel” for the art market. The bill’s passage has likely pushed some transactions forward into the last two weeks of the year, he said, at least from what he has observed anecdotally.
“There are a lot of tax advisors who have been busy doing 1031s that are going to expire by the end of 2017,” he said.
The bill also raises the estate and gift tax exemption from $5.6 million to $11.2 million per person, which “may make this a good opportunity for collectors to revisit their estate plan and think about how their art might fit into their overall estate plan,” said Saviano.
Woodham said one potential, and slightly counter-intuitive, effect of the bill could be to encourage wealthy art collectors to donate more of their art to museums, if their children are able to inherit even more wealth without paying estate taxes on it. He envisioned collectors thinking to themselves, “Rather than the kids needing more money, let me pass the object on.”
An earlier version of this article incorrectly that the tax bill raises the estate and gift tax exemption from $5.49 million to $5.6 million per person. This was the original tax limit introduced in October, but has since been doubled to $11.2 million per person in the final bill.