How the IRS classifies your interest and intentions determines whether you can deduct expenses related to producing, acquiring, managing and selling works of art.
Art appreciation goes beyond the aesthetic. If you truly appreciate art, you may spend significant amounts of money to support that passion. Purchasing art can include expenses for transportation, storage, display and insurance, as well as fees for appraisals, conservation and restoration.
Conscientious stewards of financial resources look for ways to offset such expenses with tax rules. Fortunately for art lovers, there are some federal tax deductions that apply to art purchases. The types of deductions available depend on whether the Internal Revenue Service (IRS) classifies you as an artist, dealer, investor or collector.
In general, artists, dealers and investors can claim any expenses related to creating, acquiring, preserving or transporting art if they are incurred as normal and ordinary business expenses, or if they are incurred in the production of income. While collectors are not able to take these types of deductions, they do get tax benefits when selling or giving away their collections.
Artists. This category is straightforward and describes the people who create works of art. Tax rules are not especially favorable toward artists.
Dealers. This classification is intended for people who engage in the business of dealing art. The IRS determines this status on an individual basis, considering things like sales activity and efforts and intentions upon acquiring a piece of art. To be classified as a dealer, you must demonstrate that your interest in art is not just a hobby, because expenses and losses associated with a hobby are not tax deductible.
Investors. Like dealers, investors must show that their interest in art is more than a hobby. To be classified as an investor, an individual must show that art is collected primarily for investment purposes. To determine this status, the IRS will consider the purpose for which the piece was acquired, the length of time of possession, the investor's other business interests and the use of the proceeds from the sale of each work. To be an investor, an individual must sell, or be willing to sell, a piece of art for a profit. The IRS has denied many individuals investor status because they could not document that they ever sold a piece from their collection.
Collectors. Most art purchasers are classified in this category. Collectors are those who appreciate art and accumulate it for personal enjoyment. While expenses for acquiring and maintaining art are not deductible for collectors, favorable tax treatment often can be received when selling or giving collections away.
Although artists, dealers and investors can deduct business expenses related to producing and selling art works, they do pay taxes on the sales of their art. The art sold by artists and dealers is considered inventory, which means sales are taxed generally at rates of up to the highest ordinary income tax rate, which is currently 39.6%.
When investors sell works of art, they are acquiring gains on their investments, similar to selling stock for a profit. As such, those sales are subject to the capital gains tax rate, which is 20% for taxpayers in the highest tax bracket.
The long-term capital gain rate for collectibles, which may apply to both investors and collectors, is 28%. In addition, the Patient Protection and Affordable Care Act of 2010 added a 3.8% surtax on net investment income, which includes collectibles, for certain high income investors and collectors. Therefore, investors and collectors in the highest income tax bracket could pay a tax of up to 31.8% on the sale of collectibles.
Rather than assuming you'll be able to write-off the money you spend on art, take the time to figure out how your interest in art will be classified. By understanding the nuances associated with acquiring art, you can make better, more informed spending decisions.
1. All tax rates as of May 2016.