Magazine article The CPA Journal

The Art of the Deal: Tax Consequences of Collecting

Magazine article The CPA Journal

The Art of the Deal: Tax Consequences of Collecting

Article excerpt

Artistically minded taxpayers need to be knowledgeable atout 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.

Collector. 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 torrows money to purchase a work of art cannot deduct the interest, because it is classitied as consumer interest. The only benefit of collector status is that the collection is considered a capital asset rather than inventory.

When 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.

A collector 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.

Dealer. 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 1RS could argue that the activity is only a hobby. Most private ail dealers are full-time, because closing a single transaction may take weeks, months, or even years.

Proving 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.

Investor. 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 ait 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.

For some advice on how to start collecting artwork and learn more about appreciating art, see the Sidebar.

Tax Benefits

A significant concern for anyone who owns art is qualifying for the lower longterm 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. …

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