Just Where Is the Art Market Headed?
December 07, 2021
By Sheila Zamanian
Marie Arrigo, partner and co-lead of EisnerAmper’s National Family Office practice, moderated a webinar on the future of the art market. The panelists included Barbara Taibi, partner in the Personal Wealth Advisory group at EisnerAmper; and Elizabeth von Hapsburg, Managing Director of Winston Art Group, the largest independent art advisory and appraisal firm in the country. The session covered changes in the art market, trends over the past couple of years, and what is on the horizon for collectibles investors.
Art and Technology
Liz began the session by discussing the biggest trend impacting the art market: technology. Until a few years ago, art-related technology was limited to online databases and collection management systems. Now, there’s an enormous increase in the number of technology-based platforms available. These include Live Art, which tracks both major and regional auctions and art sales statistics, and Thread Genius, which tracks patrons’ interest and can promote available art based on this data.
Non-fungible tokens (“NFTs”) have come to the forefront. An NFT is a unique unit of data stored on a digital ledger (blockchain). NFTs are considered a type of cryptoasset associated with easily reproducible items that use blockchain technology to provide proof of ownership—analogous to a certificate of authenticity. This makes them ideal for the use of buying and selling digital artwork or other unique pieces. Just this year, a digital piece by artist Beeple sold for more than $60 million at Christie’s, and Jack Dorsey (founder and CEO of Twitter) sold his first tweet as an NFT for nearly $3 million. Although these works are readily viewable by the public, NFTs ensure ownership to only the buyer. The use of NFTs has also attracted a younger, more sophisticated market that is steeped in cryptocurrency.
Barbara next discussed how NFTs create multiple taxation events—a potential goldmine for the IRS. Purchasers dispose of fungible cryptocurrency to obtain NFTs. Therefore, capital gain is recognized on the increase in value of the cryptocurrency. For example, cryptocurrency purchased in 2017 for $100 that is now used to buy an NFT worth $1,700 creates gain of $1,600. If the NFT is then sold or flipped, capital gain is recognized on this transaction as well. This will be taxed at the collectibles rate of 28% instead of the more favorable capital gains rates. If held in the short term, then it is taxed at ordinary income rates. Furthermore, consider that net investment income tax will apply above a certain threshold.
Creators of art and NFTs have even more taxation challenges. Creators do not have any basis in their self-created intangible assets, except for minor selling expenses, which can lead to huge gains. NFTs may be considered inventory to digital artists or art dealers, the sales of which are taxed as ordinary income rates. The sale of NFTs may even be subject to self-employment tax for an artist who is in the business of adding NFTs to his/her income stream.
The art market has changed dramatically since the onset of the pandemic in ways besides technological innovation. Dealers that typically promote only their own artists are now consolidating to increase budgets and the range of services provided. Auction houses have pivoted away from public auctions and toward private sales to make up for the 30% decrease in revenue. Cross-category sales are becoming increasingly popular as customers desire best-in-class trophy works as opposed to numerous works of a single category. Online bidding sales have doubled since 2019, and pricing has become transparent as dealers turn to virtual gallery presentations. Both trends are a great boon to online collectors.
Certain categories of art are enjoying increased popularity these days. Contemporary art is driving the market as it makes up at least 55% of sales. Productions by female artists, African American art, and trophy works are all trending as well. The demand for watches has also increased, driven by the predominance of social media marketing. Other strong markets that are not typically discussed include couture, sports and Hollywood memorabilia, jewelry, classic cars, and whiskey, which has been soaring. In 2019, two bottles of 1926 Macallan whiskey sold for $1 million and $1.1 million, respectively.
Charitable Contributions and Other Transfers
When it comes to itemized deductions on personal income tax returns, state and local taxes are currently limited, medical expenses are only deductible in excess of a floor percentage, and mortgage interest is also limited based on the amount of the associated loans. Charitable giving is one of the last remaining ways to maximize deductions, but these transactions are also highly scrutinized. Consider these rules before making a large donation:
- Related-Use Rule – Artwork donated and used in a charity’s tax-exempt function get the benefit of being valued at fair market prices. If artwork was donated to a charity that will not use it in its tax-exempt function (say, a hospital), the donation is limited to the lesser of cost or fair market value.
- Adjusted Gross Income Limitations – Non-cash gifts of appreciated long-term property are limited to 30% or 20% of AGI, depending on the recipient.
- Substantiation Requirements
- Charitable contributions between $250 and $500 require written acknowledgement from the charity and a good faith estimate of the fair market value.
- Between $500 and $5,000, you’ll need the above plus records showing how and when you obtained the property and its cost basis.
- More than $5,000, you’ll need all the above plus a qualified appraisal. Qualified appraisers are not easy to find, especially toward the end of the year, so plan ahead.
- More than $20,000, the appraisal must be attached to the return, and you can expect an audit by the IRS Art Advisory Panel.
- For art valued at more than $50,000, obtain a statement of value from the IRS to avoid an audit altogether.
- Charity Disposition – Before you donate, find out how long the charity will keep the artwork. If it is sold within three years, the donor must recognize ordinary income on the difference between the deduction taken and the donor’s basis.
Aside from charitable giving, there are other methods of transfer. The Tax Cuts and Jobs Act of 2017 narrowed the definition of like-kind exchanges (aka 1031 exchanges) to exclude artwork, so these transactions are no longer eligible to defer gain. Disposition within a Qualified Opportunity Zone (“QOZ”) can help defer gain, but this method has not gained much traction. Gifting artwork to family or friends, with the help of an estate planner, can help determine the most beneficial timing of such transfers. Gift recipients do have carryover basis in the asset.
If you’re not ready to completely relinquish your artwork, consider a trust with a lease-back provision or gifting a fractional interest of the artwork. Leasebacks are becoming hugely popular since like-kind exchanges no longer apply, and QOZs don’t appear to be an effective way to transfer art from generation to generation. In a leaseback, a collector makes an irrevocable taxable gift to a trust, then the collector leases the art back to themselves. The value of the rent is determined by a qualified appraiser, and any rental income goes to the trust. Tread carefully with this route. Liz and her team use a fair market appraisal and a rubric of weighted factors to determine a percentage of annual rental value. The IRS closely scrutinizes these leasebacks and will begin to litigate them within the next year or two.