Paintings, sculptures and other types of art carry potential tax advantages to their owners alongside their aesthetic beauty.
Charitable donations, trust planning, loss-harvesting strategies and the stepped-up tax basis of assets upon the death of the owner represent some of the opportunities available to financial advisors and their clients. While the IRS has warned wealthy art owners and their tax professionals about bad actors' inflated promises of lucrative savings, high net worth and ultrahigh net worth clients have displayed enthusiasm for investing in the asset class, and the largest international shows draw countless financial firms eager to find business.
Art is "not something that comes up all the time" in discussions with clients, Roshan Weeramantry, a partner and co-head of wealth management at Everett, Washington-based registered investment advisory firm Helium Advisors, acknowledged in an interview. Still, the "important thing is just to have the conversation" because clients may have acquired tens of thousands of dollars worth of art over the years that "should be involved in the financial planning process," he said. For example, charitable deductions can spread out as long as five years, and a client with an income of $400,000 could slash as much as $120,000 off that amount and push their federal rate down to 24% from 32% through making a donation, Weeramantry noted.
"We have the conversation quite often around the benefit of incrementally donating over the course of their lives," he said. "We try to really toggle it so that we can help our clients minimize their taxes from year to year as much as possible."
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The value of those donations could reduce or cancel the tax impact of capital gains from selling appreciated stock or the added income of a required minimum distribution from an individual retirement account, he pointed out. Alternatively, if a qualified charity uses the art in furtherance of its mission and any piece worth over $5,000 receives an appraisal, the donor can get a deduction for the fair market value, according to Allen Laufer, a managing director and the director of financial planning with Silvercrest Asset Management Group, a New York-based RIA.
"Consider utilizing a charitable remainder trust (CRT) for the sale of artwork," Laufer said in an email. "The CRT allows you to defer the capital gains tax on the sale of your art and reinvest the full sales proceeds. The immediate financial benefits you receive from creating a CRT is tax-deferred diversification of a low-cost asset, the ability to invest the pretax proceeds from the sale of the artwork into a diversified investment portfolio and receive an income tax deduction based on the present value of the remainder interest that will ultimately pass to charity."
Even though capital gains avoidance always looms large for art investors, the higher cost of borrowing under the elevated interest rates of recent years is likely driving down art sales, according to a blog post last month by Howard Gleckman, a senior fellow with the Urban Institute and Brookings Institution's Tax Policy Center. The use of debt provides further tax deferral on top of the stepped-up basis, which enables the heirs who receive the asset upon the death of the owner to evade any capital gains tied to its growth in value.
"Crucially, any increase in the value of an asset is untaxed until it is sold. And if owners hold it until they die, no tax ever is owed on any increase in its value during the decedent's lifetime, thanks to something called stepped-up basis," Gleckman wrote. "This system creates enormous incentives for art aficionados to avoid selling assets to finance their next Warhol and, once they buy it, to find ways to monetize its value without ever selling it."
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The stepped-up basis works the same with art as it does with homes or any other asset, but advisors and their clients should remember that the decedent's estate must pay taxes on the appreciation over their lifespan, Weeramantry noted. With the current higher exemptions on estate taxes up to 40% set to expire at the end of next year, the "massive benefit to the step up in basis" could look different for families that no longer qualify in 2026, he said.
One provision of the Tax Cuts and Jobs Act of 2017 that is permanent, however, removed the ability for advisors and their clients to use "like-kind" 1031 exchanges that defer capital-gains taxes for swaps of art or other collectibles, Laufer noted. The elimination of that method added to the importance of other tools that can offset capital gains, such as harvesting stock portfolio losses that occurred in the same year as the sale of an art asset. That brings "permanent tax savings for the seller" because long-term art assets that have appreciated in value are subject to a 28% rate on the gains — compared to the 20% hit on most portfolio investments, he said.
In general, advisors and clients should figure out whether the art buyer is simply acting as a collector engaged in a hobby or as an investor seeking a profit, according to Laufer. The latter classification enables clients to deduct any losses on the sales of art and expenses relating to the maintenance of the works.
To qualify, the client "must demonstrate that they are engaged in the activity with the objective of making a profit," he said. "Taxpayers bear the burden of proving a profit motive, which requires an analysis of the facts and circumstances. While no single factor controls, some factors considered in determining a profit motive include the time and effort devoted to the activity, the expertise of the taxpayer or their advisors, expectation of profit and the history of income or loss. It is important for taxpayers to maintain thorough records of purchases, expenses and appraisals."
