There are few financial decisions these days that do not involve taxes. Buying, owning and selling art generate significant tax liabilities that art collectors need to be aware of. This is the second article in a three-part series on art and taxes. Let’s take a closer look at how the sale of a painting can affect a collector by virtue of capital gains tax.
RELATED: Art And Taxes Part III - Impact Of Estate Taxes On Art Ownership
Art and collectibles are considered capital assets. Let’s assume you just sold a painting you owned. The amount you bought the painting for is referred to by the IRS as your basis. If you received the painting as a gift or if you inherited it, your basis is fair market value at the time of the gift or inheritance. Fair market value is defined by the IRS as ‘the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts’.
Different Art Appraisals For Different Purposes
Collectors often confuse appraisals for insurance purposes with appraisals done for tax purposes. Here is the difference: insurance appraisals are based on retail values plus a bit more to cover expenses. The purpose of insurance is to be able to replace the lost or damaged object with something very similar, which is often more costly than what the original object was worth. Insurance values, therefore, have little to do with fair market value. The IRS considers the auction, rather than retail, market the most appropriate marketplace for determining fair market value.
Short Term And Long Term Capital Gain
The difference between your basis and the price you sell the painting for is either a capital gain or a capital loss. Collectors can’t deduct expenses such as insurance or restoration, unlike artists or investors. Artists, instead of paying capital gains tax, pay regular income tax on the sale of a painting. Capital gains and losses are either short-term (you have owned it less than one year) or long-term (you have owned it more than one year). Short-term capital gains are taxed at your ordinary income rate. Long-term capital gains are taxed at a maximum of 28%. Therefore, in addition to your sales costs (i.e. commissions, insurance, transport) the sale of your painting has the potential to generate a hefty tax bill.
Read more about capital gains taxes or fair market value for art and collectibles on the IRS website.