30 Apr 2012

Beware of Artists Bearing Gifts

It is always nice to receive a gift. As my mom told me and my siblings repeatedly when we were growing up, “you should appreciate the gift because it’s the thought that counts, not whether or not you like the actual gift.” However, you should be aware that if you receive a gift of artwork from the artist who created it, you will be subject to the same (potentially less favorable) income tax treatment as the artist would if you later sell the artwork. When an artist creates a work of art, he or she has no income tax basis in the artwork (or may have a minimal income tax basis equal to the cost of supplies that the artist used to create the artwork). If the artist sells his or her artwork, the profit the artist makes on the sale (i.e., fair market value of the artwork minus the income tax basis) is taxed at ordinary income tax rates, not the potentially favorable (i.e., potentially lower) capital gains tax rates. If the artist dies owning his or her artwork, the artwork receives an income tax basis adjustment equal to the fair market value of the artwork as of the artist’s date of death.

In contrast, when a person who is a collector and not a dealer buys artwork, he or she receives an income tax basis in the artwork equal to the price he or she paid to purchase it. On a subsequent sale of the purchased artwork, the person will be taxed on the profit he or she makes (i.e., fair market value of the artwork minus the income tax basis) at capital gains tax rates (if he or she meets the holding requirements) rather than ordinary income tax rates. Also, the capital gains tax rate for artwork is 28% and not the more favorable 15% rate that applies to the sale of other capital assets. Capital gains tax rates may be more favorable (i.e., lower) than ordinary income tax rates if the seller is in a high income tax bracket. If the person dies owning the artwork, the artwork will receive an income tax basis adjustment to the fair market value as of the person’s date of death.

I am not suggesting that you decline a gift from an artist even though you may receive potentially less favorable income tax treatment when you sell the artwork; remember when you receive a gift, it is the thought that counts. But, you should be mindful of the income tax consequences should you decide to sell the artwork.

If you would like to discuss this or other trusts and estates issues, please contact the attorneys at Drucker Law Offices, 468 North Camden Drive, 2nd Floor, Beverly Hills, CA 90210, 310.285.5375 Tel, 310.444.9754 Fax, www.druckerlaw.com

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