Forbes recently published an informative online piece on a new IRS Revenue Procedure that makes the use of Charitable Remainder Trusts (CRTs) as a means for tax deferral more achievable for art and collectibles.  CRTs are generally used by those who are charitably minded and wish to sell a highly appreciated asset without having to pay a significant capital gains tax bill.

If the appreciated art is sold unconditionally by an art collector, the art collector, of course, would be responsible for income tax on the gain in the year of the sale.  However, if the appreciated art is sold by a CRT, which is typically exempt from state and federal income taxes, the gain is taxed over a period of time as distributions are made from the CRT.   In the meantime, the complete amount of sale proceeds unreduced by taxes can be reinvested by the CRT.  Moreover, in the year the art is sold by the CRT, the art collector is eligible to take a charitable deduction on his or her individual tax return in which such deduction is based on the remainder value of the CRT that is projected (based on specific IRS formulas) to be given to charity.

So exactly how does a collectibles CRT work?  Generally, art is transferred to the CRT by a collector and that art is sold by the trustee of the CRT who reinvests the proceeds in a portfolio of stocks and bonds.  As discussed above, the transfer of art to the CRT and the subsequent sale of the art will not result in a current capital gains tax bill for either the art collector or the CRT.

The CRT then makes a series of annual payments to a non-charitable beneficiary, usually the art collector who created the trust (or a family member) for his or her life or for a term of years.  The annual payments to the art collector or family member will be made from the CRT’s portfolio of assets, and the amount will vary depending on the structure of the CRT.”

This new change by the IRS is considered to have come at an “opportune time” with the Federal Reserve expected to increase interest rates later in the year as CRTs are most effective in higher interest environments.  In the meantime, art collectors may wish to consider this new IRS Revenue Procedure as we wait to see what happens with federal interest rates in the months ahead.

 

 

 

 

The New York Times recently featured an interesting article on the rapid growth of free ports around the world used by collectors and dealers for the temporary storage of art works.  Many would be surprised to learn that more than a million of some of the most treasured art works ever created, such as ancient Rome treasures, museum quality paintings by old masters and an estimated 1,000 works by Picasso, are crated or sealed in tight storage vaults within the walls of such storage facilities.

With the rise in the price of art, masterpieces and other exquisite art works are increasingly being stored away in free ports by collectors who are interested in seeing such works appreciate in value rather than filling up wall space to be viewed.  As collectors become more financially savvy with art being treated as a capital asset in their portfolios, free ports have effectively become the support for all of this.

This recent upsurge in the use of free ports by collectors has led to concerns over the use of such storage spaces for illegal activities as well as worries in the art world on the effect such wholesale storage has on art itself.  Within the last few decades, a small group of free ports have increasingly served as “storage lockers” for the wealthy.  Free ports are geographically located in tax-friendly countries and cities and offer attractive savings and security to collectors and dealers alike.

In addition to the at least four major free ports in Switzerland that specialize in the storage of art and other luxury goods, such as wine and jewelry, there are four more free ports around the world, including Singapore (2010), Monaco (2012), Luxembourg (2014), and Newark, Delaware (2015).

Out of concern that these rapidly growing private storage spaces could become havens for various illegal activities (i.e., contraband, money laundering, etc.), Swiss authorities initiated an audit back in 2012, the results of which revealed a significant increase in the value of goods stored in some warehouses since 2007 with an increase in high value goods such as art.  The audit estimated that there were more than 1.2 million works of art in the Geneva Free Port alone in which some of the art has not left the facility in decades.

Many in the art world remain critical of free ports.  With many valuable masterpieces being stored outside of public view, critics argue that works of art are created to be viewed.  Those who disagree point out that paintings are not a public good as much art work was created as private property. Others say that free ports represent a financial system in which investors lack a connection with the art they purchase, but recognize that the storage warehouses enable responsible collectors to manage their art collections and limited wall space.

Collectors and dealers often decide to utilize the free ports for the storage of their art for more common reasons than tax avoidance.  Some collectors and dealers simply have no more room in their homes and galleries.  In a free port, their valuable art works are protected in climate-controlled environments behind fire-resistant walls and often under video surveillance.  Some of the free ports even have viewing rooms where collectors can view their art and show it to potential purchasers.

According to an officer of the Geneva Free Port, as a result of the audit, the Swiss have been working to address concerns over the lack of transparency.  As of this September, all storage contracts will require clients to allow inspections of any archaeological artifacts they would like to be stored at the facility.

Only time will tell whether additional free ports across the world will take steps towards increasing transparency as to inventory and ownership as collectors and dealers continue to store their valuable art works in such warehouse facilities.

Southwest Airlines’ Heart of the Community program, launched in 2014, has given a $200,000 creative place-making grant to Minneapolis’ Hennepin Theatre Trust.

Last year the Hennepin Theatre Trust spearheaded two mural projects: a five-story-high mural of Bob Dylan (corporate sponsor: Goldman Sachs) and a smaller pop art style mural (corporate sponsor: American Express). It continues to run the ongoing Made Here urban walking gallery project. The trust is seeking public input on how best to use the grant.

The Wall Street Journal recently reported that the irrevocable trust, a common estate-planning tool, is increasingly being used by art owners as a tax-savings measure.

Here’s the gist.  An art owner gifts ownership of his or her painting or art collection to an irrevocable trust.  The painting is no longer part of the art owner’s estate, and so the value of the estate is reduced for tax purposes.

In addition, the painting is appraised at the time of the gift.  The amount of the appraised value above the $14,000 annual exemption from gift taxes will be deducted from the art owner’s lifetime combined federal gift-tax and estate-tax exemption (currently $5.45 million).   If that exemption has already been used up, the art owner will pay tax on the gift – however, this tax liability will likely be less than if the art owner keeps the painting in the estate.

Read more here.

News media reports that 2016 may be a challenging year for the art world.  Christie’s and Sotheby’s, the two largest international auction houses, recently released their 2015 results.  Each auction house reported a decrease in year-over-year sales with 2015 the first year since 2010 in which Christie’s and Sotheby’s were unable to yield an increase.

London-based Christie’s reported auctions and private sales of about $6.8 billion in 2015 (down by about five percent from 2014) while New York-based Sotheby’s reported nearly equivalent sales of about $6.6 billion in 2015 (down by about one percent from 2014).

While the above figures do not signal a “burst bubble”, they do hint that this year is going to be a challenging one for the art world and reflect the volatility going on throughout the world.

In particular, cautious owners have become increasingly hesitant to sell their high-value works in a downturn.  This is evidenced by Christie’s and Sotheby’s upcoming London auctions this month of Impressionist, Modern, and Contemporary Art, which are smaller with lower estimates than same such events at this time last year.

As investment-conscious buyers become anxious about spending significant amounts of money on art works by less established artists, the so-called new category of “20th-century art” now appears to dominate the art market.  Christie’s and Sotheby’s both used this new category to promote their respective February auctions.

It appears that “rediscovered” instead of “discovered” talent in the art world is going to be “a recurring theme of a bearish 2016.”  Only time will tell.

 

 

Inc. Magazine suggests there is.

Earlier this year, Sotheby’s and Christie’s had record art sales, each selling $1 billion worth of paintings and sculptures over the course of a week.  Now art sales are in decline, as demonstrated by Sotheby’s recent struggle to meet its minimum sales level of $375 million during its old master and modernist auctions.

“While the rarefied art world may seem like it’s worlds away from the concerns of your own company, you probably want to pay attention. Not only may the paintings and sculpture you bought now fetch less money, but your own company’s value may soon slide as well.”

Inc. identifies a “tenuous” link between art sales and stock market performance, and suggests that the “hype cycle” that has increased valuations for everything from technology startups to modernist paintings is coming to an end.

Entrepreneurs are warned that this may be a sign take a more sober approach to their businesses, as the “changing winds of the art market may further signal a retrenchment in the economy.”

“The big lesson is that you shouldn’t let over-inflated valuation expectations interfere with your exit plans, which could include a sale or plans to go public.”

Read the article here.

With the upcoming launch of Skate’s Art Loans Database next week, Skate’s, the global market leader in art business intelligence, has published some analytics in an effort to measure and track the use of leverage in the art trade.  Skate’s Art Loans Database is an extensive database of all the public Uniform Commercial Code (UCC) filings that are practiced in the United States as well as some international lending transactions to secure a pledge over artworks used as collateral in art lending agreements.

As a preview to the upcoming launch, Skate’s ranks the world’s most active borrowers in the art gallery world based on the number of UCC art-collateral pledges over the past ten years (note figure in [brackets] represents the number of borrowings) as follows:  (1) Gagosian Gallery [146]; (2) Paul Kasmin [26]; (3) Wildenstein & Co. [23]; (4) Pace Gallery [21]; and (5) David Zwirner [18].  Gagosian Gallery tops the list as the most aggressive borrower, according to Skate’s data.

Skate’s notes that art galleries do not typically use art lending in their business and the combined art-lending book of the above top five art galleries is “significantly less than the art-lending books of Christie’s and Sotheby’s.”

A glimpse of the above rankings reveals the Gagosian Gallery’s secret to success may simply be that the gallery makes better use of leverage than anyone else in the art gallery world.

 

In August 2015, the combined market value of global listed art industry companies fell 21.9%.SASI_vs_SP_09_2005-01_2015

The Skate’s Art Stocks Index is designed to benchmark publicly traded companies that derive most of their revenues and profits from art assets and/or servicing art and collectibles markets around the world.

Only 3 out of 17 stocks included in the Index produced positive returns in August, but all 3 stocks (Artnews S.A., artnet.com AG, and MCH Group) are trading below their closing prices at the end of last year.  Skate’s reported that the worst performers in August were Shutterstock, Etsy, and Demand Media that each had significant negative returns this month.

The Index also demonstrates that all of the recent IPOs from the art industry are trading well below their IPO prices, which suggests art stocks are being impacted by market volatility.  Read more here.

 

Skate’s Art Market Notes for July highlight that ultra-high net-worth individuals (UHNWIs) are purchasing more art and the trend is likely to continue.  According to high-level estimates of Skate’s (based on its extensive data mining), only about 11% of global UHNWIs with assets in excess of $100 million are currently invested in art.  These figures demonstrate that there is significant growth in the art ownership penetration ratio among global UHNWIs and a significant growth upside potential remains.

Skate’s hints that with the release of its Global Art Lending Report scheduled for next month, the impressive growth of the art lending business over the past few years will be revealed and a “perfect stage” for significant growth in global art lending will be portrayed based on the following factors:

(1) very low share of art assets leveraged today; (2) historically low interest-rate environment; (3) unparalleled growth in high-end art market liquidity; and (4) quickly expanding availability of stand-alone art lenders.”

Skate’s observes that with the above four factors working in synergy together, the art market is on the brink of a “leverage boom” that should drive further high-end art sales, supporting both supply (e.g., forced liquidation of art collateral) and demand (e.g., availability of leverage for key art purchases) sides.  Skate’s points out that the United States, which is the predominant art market globally (see Exhibit 1), offers the world’s preeminent infrastructure for art lending in view of simple and efficient liens registrations for art assets via a Uniform Commercial Code filing procedure that is “increasingly used in the global art trade to secure pledge over art as loans collateral.”

To access Skate’s latest Art Market Notes for July, including the World’s Largest Art Markets by High-End Art Auction Volumes for 2014 (Exhibit 1), click here.

The International New York Times recently reported on a “little-known” provision in the federal tax code, referred to as a “like-kind” or 1031 exchange (named after the section of the tax code that allows it), which has become an increasingly used tactic among high-end art buyers who are seeking to defer or sometimes avoid federal taxes when upgrading their art work to more elite and marketable artist names.

The exchange tactic essentially enables an investor to defer paying 28 percent capital gains tax on sales of art and other collectibles, such as stamps and coins, by applying the profits from one work toward the purchase of a similar one.  Some liken the process to a no-interest loan from the government in which the investor has access to the money saved for a period of time until the asset is sold.  Two strategies that have made the tax break an attractive tool for art investors in estate planning in which they can avoid capital gains taxes include holding the art work bought with money from a previous sale until they pass away or donating it to a museum.

The use of the tax break has significantly grown in response to soaring prices for art and the increasing number of savvy investors, often from the real estate industry or Wall Street, who tend to view paintings and sculptures as “tradable commodities[,]” according to experts.

The Obama administration has taken notice and is seeking to eliminate the tax break for exchanges of art and other collectibles, which has undoubtedly spread alarm throughout the art world.  The current administration’s focus on 1031 exchanges suggests that a sizable amount of tax revenue is at stake.

Opponents of like-kind exchanges assert that such exchanges were initially intended to avoid the penalization of tax payers whose economic position did not change when assets were exchanged.  Opponents view the exchanges as sophisticated “tax dodges” exploited by investors that were never intended to be a tax tool for affluent art buyers.

On the other hand, proponents of the exchanges say the re-channeling of profits into new investments helps the economy with the promotion of growth and job creation.  Specifically, exchanges stimulate activity for art auction houses, art galleries, and their commissions, as well as financial professionals (CPAs, etc.) and art shippers – a lot of people upstream and downstream who are ordinary working people.  Proponents assert that the 1031 exchanges are based on the principle that it is unfair to tax a “paper” gain, if an investor is simply selling an asset and is quickly reinvesting the profits into the same kind of activity.

It is estimated that the elimination of 1031 exchanges could in some situations reduce gross domestic product by about $8 billion annually, according to an Ernst & Young economic study for the Federation of Exchange Accommodators.

The use of the tax break is expected to continue to grow while the art market remains confident and steady, and where buyers purchase art as an investment, not for aesthetic pleasure, according to experts.  It will be interesting to see what the future holds for 1031 exchanges and the use of same by art investors in the next few years.