Question: Any suggestions for deferring taxes on the sale of my artwork which has greatly appreciated in value?
Answer: Art collectors may face significant income tax liabilities when selling their collections. Federal capital gains tax rates on artwork sales can reach as high as 28%. Taxpayers with large capital gains and/or significant taxable income may also incur a net investment income tax of 3.8% on the gain from the sale. Factoring in the State income tax, 3.75% in Illinois, art sellers may face tax impositions of upwards of 35% on gains from the sale of their collections. Federal alternative minimum taxes may further reduce the after-tax sale proceeds.
One technique you should consider is a contribution of your artwork to a charitable remainder trust (“CRT”) followed by a sale of the artwork by the CRT. A CRT is a trust which makes current distributions to one or more non-charitable beneficiaries for their respective lifetimes or for a period of years after which the remaining trust assets pass to one or more designated charitable organizations. Although a CRT has non-charitable beneficiaries, the gain from the CRT’s artwork sale is not subject to tax at the trust level leaving the full sale proceeds intact for the generation of income and payments to the non-charitable beneficiaries. Distributions of a specified percentage of the CRT assets are paid each year to the non-charitable beneficiaries which of course can include yourself. While the CRT assets must ultimately be paid to charity, the trust instrument need not specify the charitable beneficiaries at the time of creation meaning the trust creator’s current indecisiveness on charitable wishes need not forestall the creation of the CRT.
Consider an art collector domiciled in Illinois with a zero basis artwork collection having a value of $1,500,000. Assume the collection is sold and the collector’s owner is in the maximum income tax bracket. Ignoring alternative minimum taxes, the owner would retain $966,750 after taxes for investment or other purposes. With a CRT, the full $1,500,000 of sale proceeds would be available for investment as the CRT will not be subject to tax on the gain from the sale. Income taxes will be imposed on the annual payments to the non-charitable beneficiaries based on the nature of the income derived by the CRT (e.g. dividends, interest, capital gain, etc.).
CRTs provide collectors with the opportunity to dispose of artwork at any opportune time without concern for taxes. An income tax deduction is also available to the collector upon the contribution of the artwork to the CRT. Prospective CRT creators must of course consider the inability to ultimately pass the CRT assets to younger generation family members which may give pause for concern.
While a charitable remainder trust is a desirable tool for artwork collectors, a CRT may also be beneficial in other cases. Anyone with illiquid assets which have significantly appreciated in value such as vacant land, improved real estate or even an automobile collection can use a CRT to liquidate the position and avoid income taxes. In all such circumstances, meaningful tax benefits can be realized while also benefitting one or more charitable organizations.
The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to firstname.lastname@example.org.