The Life Cycle of Art Ownership

New York City has just finished the November marquee fine art auctions. In many ways, these marquee sales are emblematic of the life cycle of art: Masterworks are brought to public sale—often by the estates of their prior owners—which draws in new collectors who then compete to purchase and build their own art legacies. Below we explore some of the essential transactional and tax considerations for each phase of the art ownership cycle.

Acquisition Phase

The art market is divided into two principal segments: the primary market and the secondary market. The primary market represents first-time art sales made by galleries or dealers directly on behalf of artists and artist studios. The secondary market represents the resale of art by galleries, dealers and auction houses on behalf of the subsequent owners of the art. For buyers in the acquisition phase, the sourcing of artworks for purchase may take them into both the primary and secondary markets, depending on their interests. 

Transactional Considerations. Documentation in the art market is notoriously slim. Buyers who are new to the industry should be aware of this reality and appreciate the need to work with experienced counsel who understand the market “buy-side” terms to include in deal documents and know which due diligence items to obtain when vetting an artwork for acquisition. While these items vary, they generally include fact sheets stating provenance, exhibition history and literature, condition reports, high-resolution photographs and title and export/import documentation. Although there is no public title registry for art, there are private registries with information about stolen art that can be reviewed for purposes of title diligence, in addition to running Uniform Commercial Code searches against U.S.-based sellers and owners of art.  

Tax Considerations. From a tax perspective, sales tax is the relevant consideration during the acquisition phase. Sales tax is a consumption tax typically collected by a seller and remitted to a state for the retail sales of goods and services within that state, although tax rates and regulatory and compliance frameworks differ from state to state. Because sales tax is determined based on the delivery destination, advance planning is key when mapping out an art transaction and identifying the potential sales tax liability. 

The power of states to collect sales tax was strengthened by the 2018 Supreme Court ruling in South Dakota v. Wayfair, Inc. Before that decision, sellers with no physical presence in a state generally were not required to collect its sales tax. Wayfair, however, authorized states to use an economic presence test (versus a mere physical presence test) to require out-of-state sellers that are making high-volume or high-price deliveries of items into a state to collect and remit that state’s sales tax on such deliveries. Since Wayfair, the landscape for art sales within the United States has significantly changed. Today, art galleries and auction houses across the country easily exceed the economic presence test thresholds and are required to collect and remit sales tax to the applicable authorities using specially designed multistate compliance accounting software. But even if a seller does not collect a sales tax, buyers should remember that states may charge use tax, which is a tax complementary to sales tax that is generally imposed by states on buyers in cases where sales tax has not been collected by the selling vendor and an applicable resale exception does not apply. 

Collection Management Phase

Transactional Considerations. Logistics and location are critical components for art collectors and art investors alike. The various locations of residences, storage facilities and museums requesting art for public exhibition drive the logistical mapping. Chief among art logistics is ensuring that the condition of art is preserved and documented. Condition reports are the name of the game in art relocations because they provide baselines for the assessment of loss or damage and assist in pinpointing responsible parties. Therefore, relocation documentation and agreements must include provisions regarding the preparation and cross-checking of condition reports. An equally important element is insurance coverage. There are various forms of fine art insurance on the market, and the key points in reviewing policies are the exclusions, the terms related to partial damage and the terms related to permitted locations. Some policies provide coverage only for certain listed locations (and may exclude transit), whereas other policies are worldwide in nature and include any transit. Understanding the terms of a policy so that you can ensure your relocations of art are not in jeopardy is paramount when owning art.

Tax Considerations. As noted above, use tax is a tax on the buyer that complements sales tax. States may assess use tax not only at the time of sale of artwork to an in-state buyer but also upon an owner’s relocation of previously purchased artwork into the state. Therefore, before relocating artwork, even if the relocation is years after its original purchase, the owner should check the use tax rules of the jurisdiction of the relocation to avoid any tax surprises. This issue is especially relevant when moving art that was previously stored or displayed abroad into the United States, because states generally do not provide credit against use tax for value-added tax (VAT) paid abroad. 

Disposition Phase

Transactional Considerations. The disposition phase is when the documentation collected during the other phases of the art’s life cycle becomes key. Preparations for dispositions will require owners and fiduciaries to provide supporting records with respect to the transfer of the art assets and the making of requested representations and warranties regarding the art holdings. In addition, when considering common disposition options—bequests, sales and gifts—art owners should ensure that their planning is well documented and holistically tied together with their overall estate and income tax plan. There are many nuances with art that are not at play with other assets classes due to the personal enjoyment element, the illiquid nature and the transportability of art.

Tax Considerations. Charitable gifts of art can be structured with sophisticated planning to achieve the art owner’s personal and financial goals. For income tax purposes, the gift of art is generally subject to a 30% adjusted gross income (AGI) limitation with a five-year carry-forward period, so it is important for clients to run the numbers with their accounting and advisory teams to optimize the potential deductibility of their art gift in relation to their anticipated income. 

When considering the sale of art, capital gains tax is typically a primary focus for owners. Art held for more than one year is treated as “collectibles” property in the hands of the owner, with the gain from its sale being taxed at a federal income tax rate of 28% (compared with a top rate of 20% on other long-term capital gains property) plus any applicable net investment tax and/or state income tax. This higher tax rate on collectibles must be factored into owners’ art disposition strategy so that it does not come as an unwelcome surprise.