Art sales at the Christie's post-war and contemporary evening sale's hit a record-breaking auction total of approximately $745 million. Such prices, as well as an increase in international art fairs and Internet purchase options, have attracted new investors to the art market in hopes of making a profit from art investments.
However, new investors, as well as many seasoned art investors, may be surprised to find a hefty tax bill resulting from the sale of their art. In 2014, the federal tax rate on gains from the sale of artwork is at a combined maximum rate of up to 31.8%, with a capital gains rate on collectibles of 28% and a 3.8% tax on investment income for certain individuals. Sellers may also be subject to additional state and local taxes on the gains from the sale of artwork. Internal Revenue Code Section 1031 like-kind exchanges present an attractive opportunity for art investors to defer capital gains recognition on art sales and not be subject to state sales tax on certain art purchases.
Investors in real estate may already be familiar with like-kind exchanges, where real estate assets are swapped and capital gain recognition is deferred. Rather than recognizing the capital gains on the sale of an appreciated asset, the tax basis from the asset that is sold is transferred to the asset that is purchased, and the capital gains tax liability is deferred until the purchased asset is sold in the future.
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However, like-kind exchanges with tangible personal property, such as art, have additional considerations with respect to sales tax issues and issues relating to the unique transactional culture of the art world that art investors should be aware of. If an art investor finds a qualified company, such as a gallery, to take ownership of the art for a brief time during the transaction, the investor may save significantly on sales taxes.
TREATMENT IN NEW YORK
When calculating the total purchase price subject to sales tax, many states, such as New York, exclude trade-in credits for any tangible personal property accepted as part payment by a vendor on the purchase of tangible personal property. Therefore, in states with such a trade-in credit, if a taxpayer exchanges art worth equal to or greater value than art the taxpayer purchased, and a vendor is used as the qualified intermediary, the taxpayer should not be subject to any state sales taxes on the art purchased. If done properly, this could result in a sales tax savings of up to 8.875% of the value of the art purchased in New York.
This sales tax exception is often overlooked by qualified companies that serve as intermediaries for real estate like-kind exchanges. Standard documents for real estate like-kind exchanges will not enable a taxpayer to take advantage of this sales tax exclusion because typically qualified intermediary companies do not take title to the art being purchased and sold, and they may not qualify as a vendor for sales tax purposes. Taxpayers seeking to achieve this sales tax benefit, in addition to the capital gains deferral benefit, should discuss with their attorneys how to properly structure the transaction to achieve both benefits.
SELECTING A QUALIFIED INTERMEDIARY
For the sales tax reason discussed above and for the notice requirement reason discussed below, many qualified intermediaries companies that are wise choices for real estate like-kind exchanges may not necessarily be the right fit for art like-kind exchanges.
For liability protection, qualified intermediary companies often refuse to take title to the property in the exchange and title will pass directly from the seller to the buyer, rather than through the intermediary. These arrangements in which the qualified intermediary does not enter the chain of title involve safe harbor notice requirements. As a result, if used in an art exchange, to meet the literal reading of the safe harbor, some qualified intermediaries will require an auction house or gallery consigned to sell the art to provide notice of the exchange arrangement to the third-party buyer. Many auction houses and galleries are displeased with having to provide this notice, and if midway through a taxpayer's exchange they do not comply and the qualified intermediary refuses to take title to the art being exchange, the like-kind exchange may fail.
Smaller qualified intermediary companies with more flexible compliance structures or art dealers who understand the complexity of the art market may be more willing to serve as qualified intermediaries in a manner that does not disturb the privacy valued in most art transactions. It is important to properly evaluate the qualified intermediary selection before beginning an art like-kind exchanges to ensure that the taxpayer achieves the greatest tax benefit from the exchange.
Diana Wierbicki is a New York-based partner at the international law firm Withers Bergman, where she focuses on art law dealing with purchases, sales, loans, consignments and charitable giving of works of art. Ms. Wierbicki is also a member of the wealth planning practice group and advises high net worth individuals and their families on tax, trust and estate planning matters, as well as on commercial transactions associated with that planning. She acknowledges Agatha Kluk for her assistance with this article.
