Works of art—ranging from sculpture, fine art, decorative arts, land art, or digital art—can be an investment to enjoy for years to come. Collectors may be interested in art for numerous reasons; the work’s beauty, its investment potential, they inherited objects, or they want to build a legacy for their family.
Regardless of why a collector builds a collection, it may help the collector to consider tax, risk, and estate complications involved in acquiring, maintaining, and planning for art. That way, the collector may be prepared for the future of their collection and potential impacts of owning an art collection.
Taxes
Sales Tax
Sales tax is due for the purchase of works of art and should be considered in the overall purchase price (as with most purchases). For sizable art collections, the sales tax is typically quite high and may be prohibitive—all the more reason to understand sales tax details as the collector and owner.
In addition, sales taxes differ from state to state, and financial strategy around that sales tax may also differ depending on where you reside.
For instance, Steve Wynn (a famous casino mogul) spent more than $300,000,000 on a magnificent art collection in just two years while he was simultaneously building the Bellagio Hotel in Las Vegas, NV. Once the hotel was completed, it eventually housed his works through an art gallery installation.
The Nevada sales tax can be reduced under a state law that allows for a tax break in exchange for collectors exhibiting the art to the public for free for 20 hours a week over nine months in that state. Wynn was able to avoid sales tax in full by becoming a licensed art dealer in Nevada, resulting in him effectively shielding $300 million from sales tax1.
In turn, collectors can choose to use freeports rather than pay sales tax on their collection. Freeports, controlled storage in a duty-free zone of a port, are found worldwide. Collectors visit the collections periodically at the freeport or ship between freeports to view the art as they travel. If the art never leaves a duty-free zone, it remains sales tax-free.
Use Tax
Art purchases may also be subject to use taxes when collectors bring the art back to their home state.
The desire of collectors to avoid heavy use taxes on their purchases has been a boon for small museums in states such as Oregon and New Hampshire, which are states without use tax. These instances can be utilized as a “pit stop” for art on the way home to a use tax state.
For example, the rule in California states that if an object goes to a museum in Oregon or elsewhere for viewing for 90 days, California considers the prior use in Oregon a first use. Thus, a 7.25% California use tax is no longer owed because it was first “used” in Oregon2.
Due to these circumstances, it’s not unusual for small museums, such as the Hallie Ford Museum of Art at Willamette University or the Hood Museum of Art at Dartmouth, to circulate short exhibitions of major works of art through their galleries.
Income Tax
Many collectors incur enormous expenses collecting art, including consultant fees, professional fees, transportation, travel, storage, environment control, and more. It is understandable that collectors seek to deduct those expenses as investment expenses under IRC Section 212.
According to Wrightsman v. United States, the reasons why a collector collects art are key to determining whether expense deductions under §212 are permissible3. While collecting artwork for the enjoyment of viewing is a valid purpose, it cannot be the purpose for purchasing for the expenses to be deductible. The primary purpose must be for an investment, and the burden of proof is on the taxpayer. This is a high bar to meet; if the art is installed at a residence, the expenses incurred in obtaining the art are likely not deductible under §212. Furthermore, under current law, investment expenses under Section 212 are not deductible through 2025.
Estate & Gift Taxes
Works of art may also be included in the taxable estate of a decedent. In 1968, IRS Commissioner’s Art Advisory Panel was created to review and value art for the government. As such, a detailed valuation by an expert is needed for any work valued at $50,000 or more, as the IRS will have a competing valuation completed by their panel of rotating experts who cycle on and off the panel every few years.
A notable example of the potential estate tax differences due to valuations can be seen in the fight over the Robert Rauschenberg masterpiece, “Canyon.” The work was first purchased by the original owner directly from the artist and includes a taxidermized bald eagle as a component. Upon inheritance, the children of the owner discovered they could neither keep nor sell the piece as it would be a felony because of federal laws enacted around the protection of bald eagles (the original owner was allowed to keep it under an informal agreement with the government, once the artist wrote a letter to the IRS indicating that the bird was killed and stuffed by Teddy Roosevelt’s Rough Riders well before the protection laws were enacted).
Since both keeping and selling were impossible, in practical terms, the family’s appraisers valued the work with a fair market value of $0. The IRS art panel valued the piece at $65,000,000 and the IRS sent the family a bill for almost $30,000,000 in estate tax (and $11,000,000 in interest). The family had already paid $471,000,000 in estate taxes on the overall billion-dollar art collection of their mother.
The case was settled in part with the heirs donating the work to the Museum of Modern Art (MOMA) in New York City, without receiving a charitable tax deduction in return. It can be seen at the MOMA today.
Risks
Investing in and collecting art can be a risky business, as much is done on a handshake and via reputation.
Unscrupulous Fiduciaries
When the painter Mark Rothko died, he named three advisors as his executors. The executors immediately formed a company together and sold all the pieces from the estate to their company for a fairly nominal amount. From there, they flipped the paintings to buyers for enormous profits. When the family discovered the self-dealing, they were able to have the executors removed.
This is just one example, but there is a keen sense of “caveat emptor” in art deals and there are unscrupulous people to assist those with money (but not art education). It is critical to do due diligence on your own, as well as with an advisor, and to read documents and study history to avoid issues.
Provenance, Stolen Works, & Repatriation
Art, like real estate, must have a good chain of title from the artist to the current owner. Unlike real estate, art titling is not officially documented outside of buyer and seller records. For old masterworks, it can be difficult to trace the provenance, which is necessary to ascertain the value of a piece. That value is partially in the artist’s recognition, and the provenance can be easily fraudulent due to a lack in official records.
The Art Loss Register was created in 1990 by major art insurers. In addition, Germany has its own Art Loss Register created from Nazi records for art stolen from Jewish families. Other law enforcement databases exist worldwide as well, including a substantial one with Interpol. Significant due diligence must be done beyond the databases, though, to fully confirm provenance and confirm items are not stolen.
Modern governments worldwide recognize the cultural value of pieces exhibited in museums of other countries without original permission. There is a growing movement of such governments requesting the pieces be repatriated. This can be easily seen by perusing the Contested Items page of the British Museum. Private parties can be subject to the same potential repatriation and restitution requests and should consider that possibility when purchasing items of cultural importance.
Planning Opportunities
The collecting of art presents tax and risk challenges, some of which can be mitigated by careful planning and preparation.
Various techniques to help collectors incorporate, value, and protect artworks as part of the estate plan include:
- Checking all appropriate databases of stolen art as part of extensive due diligence on the piece.
- Involving the estate attorney before purchase.
- Creating an LLC to obtain discounts on the value.
- Considering different tax ramifications for how art is stored, showed, exhibited, etc.
- Gathering expansive and detailed records on all aspects to preserve provenance.
- Using charitable deductions and cost-sharing with museums through long-term loans.
- Utilizing first-use pit stops with museums in states with no use tax.
- Researching art based loans, which use artwork as collateral and are sometimes available through private banks and auction houses.
- Ongoing legacy planning to help prevent surprises, expenses, and legal battles for heirs and museum beneficiaries.
Art can make a pleasurable, valuable, and treasured part of your overall asset portfolio. However, as is the case with all assets, it helps to plan for a collection and consider items (beyond their beauty) for risk and tax planning.
If you have questions or need assistance, please reach out to a professional at Forvis Mazars.