Proposed tax code threatens the American collector’s buying power, with legal expert Diana Wierbicki
LEGAL, PUBLIC POLICY AND ETHICAL ISSUES THAT CONCERN ART DEALERS, AUCTION HOUSES, COLLECTORS AND ALL THOSE WHO MAKE UP THE WORLD OF THE VISUAL ARTS, HAVE GAINED IN INCREASED SIGNIFICANCE AND FOCUS AS THE ART WORLD ITSELF COMMANDS MORE MONETARY AND INTERNATIONAL ATTENTION. HOW THE ART MARKET FUNCTIONS AND THE LEGAL RAMIFICATIONS THAT AFFECT AN ART COLLECTION AND ITS HEIRS AS WELL AS MUSEUM DONATIONS HAS BECOME AN AREA OF SPECIALIZATION AND EXPERTISE WITHIN THE PRACTICE OF LAW.
DIANA WIERBICKI, PARTNER AT THE INTERNATIONAL FIRM OF WITHERS AND BERGMAN, IS ONE OF THE MOST DISTINGUISHED SPECIALIST IN THIS FIELD AND I AM DELIGHTED TO POST HER ARTICLES ON THE LEGAL ASPECTS OF THE ART WORLD IN THE LRFA BLOG. HER AREAS OF EXPERTISE SERVE TO DOCUMENT HER EXTENSIVE PROFESSIONAL ACCOMPLISHMENTS AND ALSO PROVIDE US WITH A RICH CROSS-SECTION OF THE COMPLEXITY AND NUANCE OF ART LAW ITSELF.
• Preparing complex like-kind exchange agreements involving works of art.
• Negotiating multi-million dollar sales and purchases by museums, collectors and dealers, and addressing related sales and use tax issues.
• Structuring complex gifts involving works of art.
• Advising on the auction purchases of works breaking record prices.
• Negotiating appraisal and consignment agreements with the major auction houses.
• Negotiating private sale transactions.
• Negotiating loan agreements with over one hundred museums and other institutions around the world.
• Negotiating contracts between collectors and vendors of art-related services.
• Advising major artists and photographers about their estate planning and the formation of foundations to preserve their artistic legacy.
• Advising collectors on their estate planning and the formation of foundations and museums.
DIANA, THANK YOU FOR YOUR GENEROSITY IN SHARING YOUR LEGAL EXPERTISE WITH US IN THE LRFA BLOG.
The President’s Attack on Like-Kind Exchanges
by Diana Wierbicki
May 6, 2015
The Fiscal Year 2016 Budget proposes a modification of like-kind exchange transactions. As in the Fiscal Year 2015 Budget, the Administration proposes to limit the amount of capital gain deferred under Section 1031 of the Internal Revenue Code from the exchange of real property to $1,000,000 (indexed for inflation) per taxpayer per taxable year. The Administration now also proposes that art and collectibles no longer be eligible for like-kind exchanges. The proposal only applies to like-kind exchanges completed after Dec. 31, 2015.1
How Like-Kind Exchanges Work Now
The current version of IRC Section 1031, which regulates like-kind exchange transactions, provides that in general “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”2 There are no current limits on the value of the property. However, limits on the types of property that can be used as part of a like-kind exchange already do exist. A taxpayer can’t use stock in trade or other property held primarily for sale, stocks, bonds, notes, other securities, evidences of indebtedness or interest, interests in a partnership, certificates of trust or beneficial interests or choses in action as part of a like-kind exchange.3
Like-kind exchanges enable a “deferral” of capital gains tax, not an “avoidance” of tax. If an individual purchases art for $100,000 and later sells the art for $150,000 in cash, the individual’s $50,000 gain is recognized and subject to tax. If, instead, the individual reinvests the $150,000 in other art, no gain is recognized on the exchange; therefore, no tax is due at that time. If later, the individual sells the art for $250,000 in cash, gain is recognized on $150,000 (the sale proceeds minus the original cost basis of the first work of art exchanged). The $150,000 will be taxed at the capital gains rate for collectibles in the year that the cash is received. This rate may be the same, higher or lower than that in the year of the exchange, so the individual is taking a gamble when deferring.
Proposal Decreases Buying Power of U.S. Art Investors
If passed, the proposed exclusion of art and collectibles from being used in like-kind exchange transactions would be yet another provision in the tax code that could discourage individuals from investing in art. Gains from the sale of art and collectibles are currently taxed at a 28 percent federal rate, the highest federal tax rate for capital assets held for over a year.4 When factoring in other federal and state taxes that art sales may be subject to, an individual could face an over 40 percent tax on the sale of art. If that individual had sold art for the purpose of reinvesting in other art, the individual would now have 40 percent less cash to reinvest in the art market.
This decrease in buying power could affect the United States’ position in the global art market. The United States is one of the few countries that taxes its citizens on their worldwide income, regardless of where it’s earned. As such, U.S. citizens receive no income tax benefit from conducting art sales in “freeports” (customs zones in which taxes and fees are not charged by the country in which the zone is located) the way that citizens of other countries do. For instance, if a Chinese citizen who’s residing outside of China sells art in a Swiss freeport, the gain from the sale would not be subject to tax because China, unlike the United States, doesn’t tax Chinese citizens on income earned outside of mainland China, and Switzerland doesn’t charge a tax on transactions conducted in its freeports. The Chinese citizen would then have 100 percent of the sale proceeds at his disposal to reinvest in art. The United States does tax U.S. citizens on sales that occur in freeports, so a like-kind exchange serves as an important mechanism to even the global art market’s playing field.
Diana Wierbicki is the Global Head of the Art Law practice 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.
I LOOK FORWARD TO POSTING ARTICLES WRITTEN BY DIANA IN FUTURE BLOGS.
IN OUR NEXT LRFA BLOG, I AM DELIGHTED TO INTRODUCE JESSICA HODIN, CROWDFUNDING MANAGER AT ART BASEL. JESSICA WILL SHARE HER EXTENSIVE CURATORIAL BACKGROUND AND HER PERSPECTIVE ON ARTISTS OF NOTE IN THE CURRENT CONTEMPORARY SCENE AS WELL AS HER WORK WITH ART BASEL AND ITS SUPPORT OF NONPROFIT ART ORGANIZATIONS AND PROJECTS.
JESSICA IS ARTICULATE AND PERCEPTIVE WITH A WIDE RANGE OF PROFESSIONAL EXPERIENCE THAT INCLUDES ART ADVISORY SERVICES AND ONLINE AUCTION.
THANKS FOR READING!