On-Demand: The Future of the Art Market
November 04, 2021
By Barbara Taibi and Marie Arrigo
In this webinar, EisnerAmper’s Personal Wealth Advisors and The Winston Art Group discuss current and emerging trends within the art world including non-fungible tokens (“NFTs”), use of technology in forecasting, and dealer consolidation.
Marie Arrigo: Thank you. Barbara.
Barbara Taibi: Thank you, Marie. Hi, all, I'm Barbara Taibi and I am a partner in the Personal Wealth Advisory Group at Eisner. My client base consists of a lot of our high net worth families, individuals, C-level executives, I do some trust and estate work, and it's a pleasure to be here today.
Marie Arrigo: Thank you, Barbara. So, let's get started. First question is for Liz. What trend have you seen as having the biggest impact on the art market?
Elizabeth von Habsburg: Thanks, Marie. I think you'll see here in this slid how I'm going to start this presentation. The past few years have been really a game changer in the art market with technological innovations bringing the art market more in line with other asset classes. Up until a few years ago, we really only saw kind of technological platforms like the various databases, which were online, Artnet, Artprice and so on. And we also had collection management systems, a plethora of them, that clients use to track their collections.
However, in the past two years, we've seen an enormous increase in the number of innovative technologically-based platforms. And here are just a few that you see on your screen. On the upper left is Fair Warning, which was started by Loic Gouzer, who was a senior specialist at Christie's, really taking the online platform for auctions to the next step.
In the middle, LiveArt is a great app that we use all the time and that tracks all of the major auctions as well as regional auctions and gives us incredible information and statistics on each sale. Upper right, is our platform for tracking collections of wine. And this is innovative in the fact that it tells our clients when to hold, when to buy, when to drink, or when to sell each bottle in their collection.
On the lower left, you see Thread Genius, which is a very interesting platform that Sotheby's has developed, that uses algorithms to track what works of art their clients are interested in, so they can promote works of art to their clients based on their bidding and other interested questions that they've asked the auction house.
And then finally, lower right, and these are just a couple of the many, many technological innovations we've seen, but Articker is a joint venture between Phillips auction house and Articker, and that has tracked and promoted emerging artists based on, again, an algorithm showing how those artists have performed and what exhibitions they've been in, what museum shows they've been in as well.
So, those are several of the technological innovations, but of course, everybody wants to know about NFTs. NFTs really came to the surface last year when Christie's sold that Beeple, Everyday: The First Hundred Days for just under $70 million. NFTs, which I'm sure most of you know what they are, but they are based on the blockchain. They're tokens that represent ownership of unique items. As I said, they're transacted on blockchain and they're immutable records of these particular codes.
So, some of the most major NFTs that have come up at auction are the ones that I'm showing you on the screen. I mentioned the Beeple, Everyday: The First Hundred Days. There is actually another one, which is not just a virtual work of art, that is both a physical and a virtual work, that's coming up at Christie's by Beeple next week. I tell all of you to go take a look at it. It's really fabulous. It's a robot walking on a movable platform, very much worth seeing.
Upper right is an example of one of the CryptoPunks, Larva Labs created 10,000 unique CryptoPunk images. This one is particularly interesting, because you can see it's wearing a mask. So, it's particularly relevant to today's world, and it sold for $11.8 million just in June. The lower left, you see Jack Dorsey's first tweet, which he made into an NFT and sold for $2.9 million not that long ago, in March of 2021. And donated the proceeds to a cause that he was particularly interested in.
On the bottom right, I think this is a really interesting one. This is an NFT by sir Tim Berners-Lee, who was really the creator of the web. And this is not the actual code, source code, because the source code is actually open to the public and freely downloadable ,and viewable, and copyable. This is actually an amalgam of a sort of code that was done at the outset of the web.
Interestingly enough, there is a mistake in the code, which somebody found not long after it was sold, but in any case, it's sold for $5.4 million, these are just examples of what's coming up on the market. And it's a very exciting market, because it's brought into the art market a whole new group of collectors. They're young, generally under 30 years old, they're extremely sophisticated with cryptocurrency, and it's really been an interesting change to the art market.
Marie Arrigo: So, actually, I see a question. I don't know if you can address it quickly since it seems to be on point with Jack's first tweet and how do you stop duplication of these? Or do you?
Elizabeth von Habsburg: Well, as I mentioned before, each one is unique and it's on the blockchain as a unique code. So, ownership is only with that person who has purchased it until they transact it and sell it again. So, yes, it can be downloaded potentially, and it can be projected, but it's not owned by anybody else except that original purchaser.
Marie Arrigo: Okay. So, Barbara, let's get to the tax implications. What are the tax implications of selling artwork in general, and NFTs in particular?
Barbara Taibi: Thanks, Marie. So, in talking about non-fungible tokens, these NFTs, we're thinking that it really could be almost a potential gold mine for the IRS, because they create these multiple taxation events. So, to start with, let's say, we have NFTs, which are considered crypto assets. So, they're usually going to be purchased with cryptocurrency. And when you purchase an NFT with a fungible crypto currency, you are disposing of that currency at the time. And you have to recognize the capital gain on the increase in that value of the cryptocurrency.
So, for example, if you had bought a unit of Ether in 2017 for $100 and it's now worth $1,700, and you're using that to buy a $1,700 NFT, you have $1,600 of capital gain. So, you can have a gain of, and now you're paying, say, 20%, plus the 3.8% net investment income tax on that, plus your state income tax.
Then, let's say you're going to trade or sell this NFT, and the buyer decides he's going to flip it, maybe sell and get a higher price for it. So, now they, as the seller, have capital gain. And since these NFTs are considered collectables, the tax is going to be the flat 28% if you hit certain thresholds and that's more than the more favorable zero, 15 or 20% capital gain rates that, say, you would get on the sale of a security or a stock.
And again, we're talking about long-term capital gain here. So, that means that you've held on to this NFT for at least a year and a day. If you decide to flip or sell it within a year, that's going to be treated as short-term capital gain. Short-term capital gain is taxed at your ordinary income rates. And again, there's always the additional 3.8% net investment income tax over certain thresholds.
When I talk about the 28% tax on collectibles, that typically pertains to all artwork, antiques, coins, stamps, wines, within the definition of collectible. And in my example, let's say that you were going to hold onto your NFT for five years, and you paid a $100,000 for it five years ago. But now it's worth 500,000 and you decide you want to sell it. So, you would have a 28% capital gain on the 400,000. And along with paying the 28%, you'd have the 3.8% net investment income tax, and living in a taxable state, you'd have the state income tax on that piece of it.
Gets even worse for creators of art and NFTs. So, because NFTs are considered self-created intangibles, the creator of them has really no basis in the NFT except for maybe some minor expenses of sale. And if you are considered a digital artist or an art dealer, NFTs could be considered inventory and the sale of inventory is at ordinary income rates, not capital gain. So, if you're at the highest ordinary rate of 37%, that's what you could be paying on the sale, not the long-term capital gain rates.
And it gets even worse if you're in the business of creating NFTs, say you're an artist or a celebrity, and you're creating these NFTs, and you're adding them into your income stream. Well, that sale not only would be considered ordinary income, but it could probably be subject to self-employment tax also. So, also want to mention that, as with the sale of any other artwork or securities, any type of gains, the gain is shown on the IRS form, 8949, and then the 8949 is then summarized onto your Schedule D of an individual's Form 1040. Thanks, Marie.
Marie Arrigo: Okay. Thank you. So, Liz, what other trends have you noticed over the past 18 plus months? Liz?
Elizabeth von Habsburg: Yeah. So, just going to say that I see a lot of really interesting questions coming in about NFTs and we will have a chance to answer those towards the end of the presentation, because they're all really good questions.
In terms of what's happening in the market, we see this incredible consolidation of dealers recently, over the past two years. Traditionally dealers had handled and promoted just their own artists, or artists that they've handled in the past. They sometimes came together to purchase works together or to handle clients together. But generally, they worked as independent businesses. Since 2020, we've seen this completely change with dealers merging together to really leverage their experience, their marketing budgets, their acquisition budgets, and to increase the range of the services that they provide to their clients.
So, you'll see here four examples of this, that have happened in the last two years, one being Acquavella, and Gagosian, and Pace, three mega dealers, who got together just in order to handle the Donald Marron Family Collection, which was several hundred million dollars worth of art, heavily competed for by the major auction houses. They were able to get it, they've done a terrific job of selling works of art, both privately and also selling some through auction.
We also saw, this year, three other groups come together to form these mega, strong dealer groups. One is the Levy Gorvy, Amalia Dayan, and Salon 94, that was founded by Jeanne Greenberg Rohatyn. They came together to form, again, a partnership. They've decided to completely forgo the US art fairs, where traditionally each of these dealers had presented their works, but to concentrate more on Asian clients to represent estate and collectors, and to really broaden their suite of services.
Also, Gagosian opened a separate Art Advisory arm in 2021, that's run by Laura Paulson, an ex-Christie's senior contemporary specialist. And then, finally, just recently, from Sotheby's, two alumni from Sotheby's, Amy Cappellazzo, who is a senior fine art specialist and chairman, and Yuki Terase, who was their senior Asian specialist, left the auction house to form Art Intelligence Global, otherwise known as AIG, again, focusing on Asian clients and the US and European clients out of New York.
So, this has been a really enormous change to the market. I think it's in response to the COVID situation that has really so badly hurt so many dealers, so many dealers went out of business, so many dealers have had a really hard time keeping up their stable of artists. So, it's an important change in the market.
And then, also, we've seen really strong effects to the auction houses. So, the auction houses that were traditionally these monoliths of auctions, with some private sales and some financing, have now really had to change their strategy and become much more effective in private sales during COVID, when auctions were minimal or the size of the auctions were smaller. The revenues of auctions, you can see here, decreased by 30% last year. So, they had to pivot into other areas that would increase their revenues.
They also, which is actually a boon for those of us who used to get so many auction catalogs, they have practically universally eliminated the hard cover catalogs or the catalogs, the physical catalogs. And now everything is online. This has allowed them to develop, again, technological resources that make viewing auction catalogs so much easier online. They have changed the auction calendar. They have merged areas of the auctions together, so you'll see something like Christie's had last year, which was a sale that had contemporary art, modern art, and an enormous dinosaur. I don't know if any of you saw it there. It was really quite extraordinary. So, mixing categories together, because we're seeing that clients are really looking for best-in-class trophy works rather than just collecting in a particular area.
We also saw online results exponentially increase last year, as everything went online or hybrid. We saw bidding online that we'd never seen before. Before COVID, I think that the highest online bid was somewhere like $3 million, could have been a little more. During COVID, the highest online bid was $70 million for that triptych of Francis Bacon. It wasn't the winning bid, it was an Asian bidder who'd never seen the work before, but we had never seen such incredible online bidding as we did during COVID.
And then, finally, dealers had to completely change the way they did business going from in-person art fairs and in-person exhibitions at their galleries to all virtual gallery presentations. But we did get this incredible transparency in pricing, where we were able to see the prices for works of art that had traditionally been kept very close to the chest by the dealers, now they are putting their prices right online. So, it's a great boon for those of us who are collecting information on the retail marketplace.
Marie Arrigo: That's great. Liz, what type of artwork is popular these days?
Elizabeth von Habsburg: All right. Very easy to say. I mentioned before contemporary art and you've read all about it in the paper. Contemporary art is really driving the marketplace, whether it's early 20th century up to 21st century art. It is now 55% of the art market at least. That David Hockney you'll see on the left-hand side is just a perfect example. It sold in 2015, that's six years ago, for 15 million, and last year for 41 million. So, works of art at the highest end of the contemporary art spectrum are really exponentially growing in value and super collectable.
We also have seen over the past five years or so, a great increase in the collecting of female artists, which is really wonderful for all of us to see, as well as African-American and African diaspora artists. Perfectly encapsulated by those two portraits you see there of Barack Obama and Michelle Obama, on the left done by Kehinde Wiley and on the right by Amy Sherald. And Amy Sherald was a perfect example of a female artist that has grown in value so much over time. In 2015, one of her works was estimated 150 to 200,000 and sold for $4.2 million. This is what we like to see in the growth of female artists and African-American and diaspora artists.
Then, the third I mentioned before in those sales that have come up at auction, Trophy Art is what the top level of collectors are looking for. And that's typified by this Botticelli, which was sold in 2021 for $92 million. So, again, at the height of COVID, an amazing result for a work of art of this type. There is another one coming up, another Botticelli coming up this year, we'll see if it equals or surpasses the value of this amazing work of art that was just sold.
And then finally, we love to look at the watch market. This is an incredible trend that started about five or even 10 years ago, but really has been so widely seen because of the predominance of social media in marketing works of art these days. This is an area that has been really driven by popular culture, by all of these stars that you see here and many more who are watch collectors. You see that statistic that's on the slide there, that over a hundred watches sold for $1.5 million or more each at auction last year, which is an extraordinary result.
And then there are some other examples of other markets that you don't really read about too much now, but that are super, super strong. One being couture, driven by the Hermes market. Another being popular culture memorabilia, with this example of an American Pie handwritten lyrics that sold for $1.2 million. Last week, or maybe two weeks ago, Sotheby's sold these Game Worn Air Jordans for $1.47 million. So, really an incredible market, but a market that has a lot of issues with the authenticity.
Or you look at those Roger Federer Tournament Rackets, which were estimated at six to 10,000 British pounds, that sold for over 160,000 pounds. So, again, that market is super-hot, super collectible. And then some others, Hollywood memorabilia, jewelry, although white and yellow diamonds have gone down in value recently, the colored stones and colored diamonds are superbly well sought after in the current market. 20th century design. And then two other areas that we see constantly in our business, classic cars, really driven by the Ferrari market, which has had three Ferrari sold in the past couple of years, two for $48 million each and one for $70 million each. And then, finally, wine, and particularly whiskey. Whiskey has been soaring as a collectible. And in 2019, I believe, it was one Macallan bottle 1926 whiskey sold for 1 million and another one sold for $1.1 million. So, these are areas that are just tremendously growing that we don't hear a lot about, but that our clients are very keen on purchasing and transacting.
Marie Arrigo: Great. So, Barbara, what have you seen regarding contributions of artwork from a tax perspective?
Barbara Taibi: Okay, I'll talk about that. But first, Liz, I was wondering how my Beanie Baby collections are looking?
Elizabeth von Habsburg: It's invaluable, invaluable.
Barbara Taibi: So, as we all know, I think art is a large percentage of many people's estate, and they look at different times in their lives as if they're going, what they want to do with it. Do they want to sell it? Do they want to gift it? Do they want to donate it? And I'd like to start-- Let's take a look now at just some of the things you need to consider if you're thinking of charitable contributions of your artwork or in some cases of any other property you might have but dealing with artwork here.
The first thing I think that's important to remember is you have to know the related use rules. And these rules apply to, say, giving artwork to a charity, and that charity is not going to use it in their tax-exempt function. So, if that were the case, then your charitable deduction is going to be limited to the lower of your cost, what you originally paid for it, or what the fair market value is of that piece of art on the day you donate it.
But if you were to donate artwork to a charity and they're going to use it in their tax-exempt function, then your charitable deduction is going to be the fair market value on the date of the contribution. So, for example, let's say you're going to donate art that you paid $1,000 for, and it's worth $5,000 now, but it's going to be a piece of art that's going to hang on the wall in a hospital lobby, most likely your tax deduction is going to be your cost, $1,000.
But if you were to take that same painting and donate it to a museum, where it's going to be used in one of their collections, most likely your deduction's going to be the $5,000, its value on the date that you were to donate to the charity. And at least as of right this minute and the way tax rules are changing constantly, but as of right now, there's no haircuts on our itemized deductions. And that's where charitable contributions come into play. It's one of our itemized deductions. And now with the SALT limitation currently at 10,000, that may change, no longer having business deductions, the 2% miscellaneous deductions. We hope we don't have much in medical. It really is charity. That's kind of one of the biggest itemized deductions that we would have on our Schedule A of our tax return. So, currently, I think people are doing a lot with it. It's one of the last remaining ways to kind of get some breaks on your tax return.
So, what do you have to look for if you are going to make a charitable contribution of artwork? There's different adjusted gross income limitations that are in place now. And adjusted gross income just means it's your total income less a few smaller deductions, like your self-employment, health insurance, or IRA, or SEP deductions, a few things there. But overall, it's almost like your gross income.
And your charitable contribution is limited by these following percentages. Now, in 2020 and 2021 only, we have this 100% of AGI limitation, which means that for cash contributions to public charities and operating foundations, you would be able to give as much as 100% of your AGI. Now, this doesn't include contributions to supporting charities or donor-advised funds. And why is that? Because this really came into play at the very start of COVID, when Congress wanted to infuse help to charities immediately.
If you have a donor-advised fund, I'll just go back so you understand how that works. Donor-advised fund gives you the current tax deduction, but it goes into this fund and you have years to decide how you want the money to be distributed out to charities. So, it's really useful to have a DAF in a year when you have a big transaction or you sell something and your income level's very high, because you create the DAF, you get the large current year tax deduction. And then over the next few years, you decide really where it is that you want your money to be put to some good work.
And that wouldn't really happen, that wouldn't be an immediate benefit to a charity. So, that's why they left those off. But if you did want to make a cash gift to a supporting organization or a DAF, then you're going to be limited to 60% of your adjusted gross income.
The 50% limit applies to non-cash gifts to most public charities, but this is excluding appreciated long-term gain property. But this could be something like even clothing going to a public charity, be a 50% AGI limitation. And most of what we're talking about here is the 30% of AIG, which these are gifts of appreciated long-term capital gain property to the public charities, private operating foundations, and to donor-advised funds. So, most common here would be appreciated artwork, appreciated securities. And lastly, there's a 20% limit of gifts of appreciated long-term capital gain property if it is given to a private non-operating foundation.
After you get through the AGI limitations, the next thing that you really have to worry about are the substantiation rules. And I have to tell you that we have to pay a lot of attention here, because a lot of the work that I do with individuals, high net worth people, they are being audited, but the IRS is in a position where a lot of the information they're getting, they could immediately match, because it's digitally being input to them. So, if you have 1099s, the IRS is getting the 1099s from the investment houses, they're matching that, they choose our match. They're getting pretty good with K-1s that are coming to you that are going to be matched.
So, all that's easy for them to take a look at and find discrepancies. But you can see, probably, where's the one area that if they want to concentrate on that, there could be some abuse? It certainly would be in the amount and the value that you're taking on a charitable deduction for a contribution I'm making. I know that I'm recently working on several of these audits, and I can tell you that, from talking to the agents, they're saying that's all that's sitting on their desk now, which are, in this case, I'm in the New York area, so you have wealthy New Yorkers who gave a large donation of either artwork or some other property to charity. And that's the only item that they're zoning in on. And that's what they want to make sure that they accept those values.
So, once you decide you're going to make this donation to charity, you have to make sure that you really look at these substantiation requirements and follow them to the T, few are very low amounts. And this is kind of a cumulative list, so as we go through every level, you got to do everything that's in the other steps and then keep adding on to it. So, it's under 250, very easy, 250 to 500, you have a written acknowledgement, $501 to 5,000 is the written acknowledgement, keeping records of the property, and cost basis. And this is the first time that the IRS Form 8283 has to now be completed. And this is the tax form that I'm saying the IRS is looking at. It's two pages long, it's got a lot of information on it, and a lot of instructions on how those different sections have to be filled out.
And I can tell you, again, from experience, if you don't do it correctly, the IRS's position is just, "Sorry, no deduction here." So, we have to be very careful, make sure you're working with the right people when you're getting into the larger donations.
And if it's over 5,000, your contribution, you need to complete the 8283, all of the items that I listed above, the acknowledgements of letters, and now you have to have a qualified appraisal of the property, and this appraisal should be dated no earlier than 60 days before you give the contribution, and no later than the due date of the tax return.
And if it's $20,000 or more of artwork, you also now must attach the copy-- Or other property. I'm sorry, artwork and other property, you have to attach a copy of this signed qualified appraisal of the tax return. Typically, anything that's on a tax return of 20,000 or more is looked at by the IRS Art Advisory Panel, a group of really smart people that take a look at things and decide if they think your evaluation is correct. Only problem there is they're really busy. They don't meet all the time. They have scheduled meetings. So, there is a delay. And if you get caught up in the audit circle, it might be a while before you find out if they're going to accept your value or not.
If you have a valuation over 50,000, you might want to consider trying to obtain a statement of value from the IRS, could eliminate some problems down the road with an eventual audit. When I talk about a qualified appraisal, that means you better have a qualified appraiser also, and they're difficult to find, they're out there. But one of the things to think about when you are looking for your appraisers, make sure he or she is knowledgeable in the area that you're looking for.
For example, if the entire bio is based on, say, Chinese art, that they've studied and are an expert in, but you have a Monet watercolor, and that's what you want valued, well, might not be the smartest thing to hire that person, because probably the IRS might scrutinize it a little bit more thinking maybe this person doesn't exactly know exactly what that's worth.
Next thing to remember is that, with artwork, you have to know what the charity, how long they're going to hold onto it. Because if the donation of the artwork is disposed of by the charity within three years, then you, as the donor, are going to need to include in ordinary income in the year it is disposed of the difference between the charitable deduction that you took and the basis, the donor's basis. So, that's your cost.
So, a couple other things to think about, and this is, I know we're getting to the end of 2021. So, this isn't going to last too much longer, but it's an interesting thing, because typically we would never advise a client to say, "Sell a piece of appreciated artwork and then donate the cash to charity." Because it typically wouldn't work out, if you had to then-- If you were selling something and you would pay the capital gains tax, and then you would get the deduction, but sometimes limited, it's always best to-- Usually had always been best to, say, just take the appreciated property and donate it directly to the charity, the gain is not on your tax return, and you get the deduction.
But in 2020 and 2021, with this new 100% AGI limitation, there could be situations where you have a highly valued piece of artwork, but you bought it at a fairly high price too, that already appreciated. So now you're sitting with it and you've got maybe just a small capital gain in that artwork. So, it really might be better to sell it, pay the small capital gains tax. And then this gives you cash, which you now can donate to a public charity, the cash, and get up to 100% of your adjusted gross income, at least through the end of 2021 only. If they extend it, we don't know yet. But that's something you might want to think about, which never really worked before.
And a couple other things, when you're planning on charitable giving of artwork, start early in the year. I know telling you that in November doesn't really help, but qualified appraisers are hard to find. And the good ones are really, really busy at the end of the year. Everybody's thinking of things that they want to do, whether for estate purposes or gifting. So, it could be really hard for you to get something done at by the end of this year already. And remember, you need this qualified appraisal for any donation over $5,000.
Also, be sure read that the charity even wants your artwork. You can go through the whole expense of evaluation and appraisal, and then you find out that nobody really is interested in it. So, you should probably take care of that before you go through any of the other steps. Be sure that the charity is going to hold on to the artwork, and find out exactly how they're going to use it. Are you going to fall into problems with the related use rules? So, you've got to check on that.
Marie Arrigo: Great, Barbara.
Barbara Taibi: Thanks. I think that's all from me.
Marie Arrigo: Have another question for you. So, is the 1031 exchange is still applicable to artwork?
Barbara Taibi: Okay, let me move on here. So, if you remember, 1031 exchanges, they were in place before 2017, which allowed you to, instead of just selling artwork, you would just exchange it for other artwork that was valued similarly to the artwork you had at the time. And you could defer that capital gain on this exchange. Well, in 2017, the Tax Cuts and Jobs Act kind of narrowed that and like-kind exchanges are really only available now to real estate and the sale or exchange of real estate. So, it's out of the picture for artwork.
So, Liz and I started talking a little bit about some of the workarounds that we have for this, and are there things that we're seeing? And I just mentioned, if you hear, just looking, it looks like, I know this isn't something that's very common, but indoor sculptures and things like that would probably still be considered as available for like-kind exchanges, because they're considered as part of the real estate. You can't take that out without damaging the structure. So, a lot of maybe the major sculptures you see with buildings could be still considered for a 1031 exchange. I'd asked Liz about the-- Was qualified opportunity zones, was that something that she might be seeing as people that are taking their artwork and then taking the gains and deferring them by getting into qualified opportunity zones, which have their own set of rules, but not really seeing that much popularity there. But it is. I'm sure some of those have been done and will continue to be done.
So, in giving away artwork, the thing that you have to really think about as a donor is, do you want to do it when you are dead? Or do you want to do it when you're alive? I think that you have to remember two things, whether when you're gifting or leaving it in your estate. And that is that, with artwork, if you're going to gift it-- And now I'm talking really about gifting to friends, family, non-charity, let's say, okay, if you're going to gift it to a family member.
The value of the art and the future appreciation of that art is out of your estate. That's probably the goal you're trying to accomplish where, in 2021, you have 11.7 million that you can have in your estate. And if you want to start to delete that amount, giving away your artwork is probably a very good idea, but just keep in mind that with lifetime giving, the person that's receiving the property is going to receive the carryover basis, meaning that they will have capital gains tax to pay when they eventually sell it, the difference between what it's worth when they sell it and what you paid for that artwork, because they're inheriting that same basis.
If the artwork remains in your estate, well, then you've had it to enjoy for all the years that you have been alive. It's part of the estate, it's part of the 11.7 million that you have to work with. And when it is then distributed to your beneficiaries, they would be getting the step up in basis to the fair market value at the date of your death. So, they would probably have very little capital gain, but it would've been in your estate and therefore it would've been subject to estate tax if you exceeded certain limits.
So, maybe you're not 100% ready for your charity or beneficiaries to take full possession of your art. I think that-- Marie, did you want me to talk about this now? I think so. I'll talk about, okay.
Marie Arrigo: Yeah, you could.
Barbara Taibi: Okay.
Marie Arrigo: Yeah. You could. Go ahead.
Barbara Taibi: All righty. So, you're thinking about this and you're just not 100% sure what you want to do. Do you want to give it completely away or maybe still hold onto it? And I know Liz is going to address this a little bit more too, but one of the things we're seeing are these trusts with lease-back provisions. So, let's say, as a collector, you're going to make an irrevocable taxable gift of the art to an irrevocable trust. What you've accomplished there is you've gotten it out of the estate.
And after you gift, you, as the collector, can lease this art back from the trustees at the fair market value of rental payments on the art, as we're going to have established by a qualified appraiser, they're going to tell you what you should have to pay to lease this back. So, now it's back on your walls, you get to enjoy it in your home. The rental income is going back into the trust. So, it's distributed to the beneficiaries, or it's used within the trust reinvestment purposes, or to pay expenses.
And for tax purposes, if we set the trust up as a defective grantor trust for income tax purposes, you, as the collector, will pay the tax on-- So, on any income generated by the leased artwork or any other investments in the trust, you're going to pay the tax on that. The beneficiaries are basically getting the use of this money undiminished by taxes. So, it's another way to give additional gifts without tax consequences. My caveat on the bottom here is, make sure you're always using a good accountant, appraiser, or an attorney, when you're setting these up, because the unintended consequence of this asset being included in your estate at the end is a really bad outcome.
Marie Arrigo: Okay. Maybe at this point, Liz, do you wanted to add, talk a little bit about the lease-back appraisals as part of this?
Elizabeth von Habsburg: Sure. Happy to jump in on that. And just to say that as 1031s are no longer allowed for artwork and as opportunity zones don't seem to be an effective way for artwork to be transferred from generation to generation, we've seen a huge increase in the number of clients coming to us for these rental lease-back appraisals. Our appraisers, who traditionally, as Barbara said, were super, super busy with donation appraisals towards the end of the year, are now incredibly busy with these lease-back appraisals.
They're not easy. There's been no determination by the IRS team as to tax cases that they have litigated on lease-back appraisals yet. But we see that coming in the next couple of years. So, we're extremely careful in how we do them. We always have to do our own fair market value appraisal first. And then, we do a rubric that is made up of 10 to 12 different weighted factors that we consider, including, importantly, authenticity and provenance and so on.
And then, based on those factors and how we've weighted those factors, we determined the liquidity and the risk for selling each work, and then come up with our percentage of annual rental. The IRS has, we've talked to them a lot about these, and they've come to, not agree, but say yes, they would tend to agree that the annual rate would be between one and 5%. They're very complicated though, and we take them extremely seriously, because we know that the IRS has told us they will be looking at them very closely. They are looking at them very closely. And they will start to litigate or to question them in the next year or two.
Marie Arrigo: Okay. That's great. Barbara, did you have any other ideas to perhaps do something differently?
Barbara Taibi: I think the last thing I really want to mention are, talking a little bit about fractional interests when we talk about artwork and, again, I'm going back to the thought that maybe you're just not 100% ready to give up this piece of artwork.
So, with a fractional interest, you're going to give a gift of an undivided portion to a charity to use in its tax-exempt function, such as giving artwork to a museum. The rule here is that your initial charitable deduction is going to be the fair market value of the art for the appraisal times the percentage that you're contributing. And what changed here probably now already many years ago, at least a decade ago, is that what we have to remember is that any subsequent deductions are going to always be limited to the lesser of the value at this time, this initial contribution time, and not subsequent donations. So, it's almost like you're not going to get the benefit of future appreciation in this artwork.
But in my example, we have Luca, who's going to donate an interest in a painting, that's now valued at $800,000, and he's going to give it to a museum for three months and he wants to keep it in his New York City penthouse for the other nine months. So, his charitable deduction is going to be limited to $200,000. That's the fair market value times three over 12 months, 25% of the year, 200,000.
But if, let's say, in year three, he again decides he wants to gift an additional three months. The fair market value of that painting is now $1 million. Well, he's not going to get a $250,000 contribution in that year. He doesn't get to use $1 million fair market value. He has to go back to the $800,000 that it was worth when he started this fractional interest contribution and used the-- And again, he gets a $200,000 tax deduction in that year, assuming he's got the income to offset that.
The museum, in this case, or the charity, has to take full possession within 10 years. So, at some point, they're going to wind up with the artwork. And it's interesting, there was just an article recently talking about the renewed popularity of this. Fractional interests have always been around, but now, post-COVID, with people moving around a little bit more, it's picked up some popularity, because let's take Luca and my example, and he's going to go-- He lives in Manhattan and he loves seeing his painting there for the nine months he's there, but in the three coldest months, he goes down to his Florida home and he never used to take the painting anyway. So, why not contribute it to charity during those three months? He's not in New York City to enjoy it, gets this large charitable deduction and eventually is probably accomplishing his goal, which was to give it away at some point anyway.
Marie Arrigo: Okay.
Barbara Taibi: Thanks, Marie.
Marie Arrigo: All right. So, I think we are up to Q&A. So, we have some questions here. I'm going to ask a few, let's see here. Do you see a time where digital can be embedded into a piece of physical art coded so that creators can participate in secondary market transactions? That sounds like a question for Liz.
Elizabeth von Habsburg: Okay. I'm going to turn it around just a little bit. I think it's a great question, but what I'd like to emphasize is that we see the importance of registering artwork on blockchain. So, if you do, and if you have a smart contract, then you can embed a royalty for either the creator or whoever in the subsequent transactions. I don't foresee something that you could implant in a physical artwork. I see it as being a blockchain transaction with a smart contract.
Marie Arrigo: Okay. So, then we say, are NFTs in a bubble or a legitimate future leg of the art world that is just beginning?
Elizabeth von Habsburg: I think it absolutely, it's a future leg of the art world that's just beginning. If you could have seen the number of the NFT.NYC youngsters that were at Christie's yesterday, crowding around the Beeple robot, you'd be convinced. I think that as crypto has a larger audience of collectors, it's just going to increase. But I do think there's going to be a recalibration as crypto becomes more-- As governments decide to put more regulations on crypto. I think it will change the market slightly, but I think it's here to stay, without question.
Barbara Taibi: There is a question about tax law changes is and how that will affect a lot of this and most of the people dealing with art are high net worth individuals. As you can see, even by-- Yesterday, our firm put out a wonderful summary of kind of where we thought the House Ways and Means was going to vote. And within a few hours, it was outdated, because they had changed things last night. So, things are changing constant-- Now they're updating it today. Things are changing constantly.
So, a week ago we thought the estate rules were going to change and that certainly was going to drive up probably more of contributions this year or donation, or gifts to family members to remove money from the estate, so we can get that number down. But that seems to be off the table now, even the tax rate increases, which originally were looked to be like 400,000 or so, maybe that's not going to start at so a high level. So, it's a moving target and we're trying to just stay on top of all of this as things change.
Marie Arrigo: And of course, we're close to year-end. So, it's hard to do planning when they keep changing the game rules here. Okay. So that's great. So, I had a question here. I think this one is for Liz, do you think our transactions will be more popular online in the future? And there's a mention of the platform Artsy, A-R-T-S-Y.
Elizabeth von Habsburg: Yeah. I think that we've already seen that change, that online bidding and online buying has increased exponentially. And in fact, something like Instagram is now being used by emerging artists to sell their own work directly to the public. So, yes, on all fronts, lots of online buying. Artsy is a great platform. It's one of many. But yeah, absolutely.
Marie Arrigo: Oops. Okay, great. All right, here we go. I lost my Q&A box there for a second. Here we go. I found it. Okay. Is there an indication of an ease off on Rolex watches? Oh, I hope not.
Elizabeth von Habsburg: The answer is yes.
Barbara Taibi: Somebody's got one home.
Elizabeth von Habsburg: It really depends on the year and the type, but yes, we've seen a slight softening on some areas of the Rolex market.
Marie Arrigo: Okay. So, I think we're almost there. We've got a couple more minutes. Is there any other comments, Barbara and Liz, that you'd like to address to the audience?
Barbara Taibi: I just wanted-- I do see some fairly specific questions about cryptocurrency trading, and I don't want to hold myself in any way out as an expert in that, but we do have some of these experts within our firm, some of my colleagues. So, I'm going to take some of these questions and run them by them and individually I can get back to some of the people asking these questions.
Marie Arrigo: Great. Great. And Liz, any other comments?
Elizabeth von Habsburg: Just looking through the questions now. Lots of really good questions, I have to say. There's a question from Mitchell on how much has the Antiques Roadshow and other similar TV programs affected the art and collectibles market? I would just say, the Antiques Roadshow is fantastic. I love watching it. But it makes it look so easy. I don't know if you remember the Carnac that Johnny Carson used to hold an envelope up and answer a question, but it seems like that with Antiques Roadshow, it makes it look really easy. In fact, there's a lot of research that goes on between the time they first see the work of art and the time they give a response. But certainly Antiques Roadshow has brought a lot of new collectors into the market, which we love. So, as the market broadens, it's good for everybody.
Marie Arrigo: Okay. Any other questions? I think there's a question out there about how to find a qualified appraiser.
Elizabeth von Habsburg: Yes, absolutely. Well, our appraisers are all qualified. You have to go through certain processes with a recognized organization, like the Appraisers Association of America or the International Society of Appraisers. And because appraisers are not nationally registered, unlike real estate appraisers, tangible personal property appraisers, do not have to be registered by the government or by the states. So, it's very important to find appraisers, as Barbara said, who have the qualifications for the type of work that you're looking to have appraised.
Marie Arrigo: And that actually—putting forth the credentials is part of the appraisal, it's actually in the appraisal to show that this is someone who actually has knowledge in the area. Let's see here.
Barbara Taibi: And I did have a situation where we had what we thought would be a good qualified appraisal and the IRS just kind of didn't like the bio of the person versus one of the pieces that was being looked at.
Elizabeth von Habsburg: Yeah. We found the IRS has been coming to us to Winston Art Group often now to check appraisals. They're getting very particular, especially about gift and donation appraisals.
Barbara Taibi: And make sure that appraisal also was saying-- It should say, is it being valued for the estate tax purposes? Is it being valued for charitable donation? The appraisals should say that. And that's something else that the IRS looks to. So, that's important to know.
Marie Arrigo: Yeah. Someone just asked about what are the qualifications for someone to appraise NFT. So, that then that could be a new subdivision, I guess.
Barbara Taibi: Yeah.
Elizabeth von Habsburg: But what I find to be even more interesting is, and I know there's some insurance professionals on this call, is how the insurance companies are going to handle the insurance of NFTs. Because that's an issue that we are watching very carefully.
Marie Arrigo: Very interesting. Very good. Okay. So, I think we're about pretty much covered it all. So I think we're pretty much run out of time here. So thank you, again, Liz and Barbara, for a wonderful presentation and thank you all for coming and listening today. Thanks again. And enjoy the rest of your day. Now, I'm going to turn it back over to Bella.
Barbara Taibi: Thank you all.