Tax Implications of Selling Artwork

How artwork is taxed depends largely on who is selling it and why they owned it. If an artist sells their own artwork, that income is treated as ordinary income. 26 US Code §1221(a)(3)(A). This is because artwork created by the artist, under tax law, has been explicitly excluded from the definition of “capital asset”. As a result, the sale proceeds are taxed at ordinary income tax rates.

The same general rule applies to art dealers. Art dealers are considered to be running a business that buys and sells art, much like any other retail operation. All income from art sales is taxed as ordinary income. 26 Us Code §1221(a)(2). However, art dealers can also deduct ordinary and necessary business expenses, such as rent, marketing, or storage costs.

In contrast, when a collector or investor sells artwork that was held for investment purposes, the artwork is usually treated as a capital asset. Any profit from the sale is generally taxed as a capital gain, which may be subject to different (and often lower) tax rates than ordinary income. US Treasury Regulation §1.1221-1(b).

If artwork is inherited, the tax rules are typically more favorable. The person who inherits the artwork receives a new tax basis equal to the artwork’s fair market value at the time of the previous owner’s death. 26 US Code §1014(a)(1). If the heir later sells that artwork, any gain is usually eligible for long term capital gains treatment, based only on the increase in value after inheritance. 26 US Code §1223(9)(B). The tax benefit often referred to as the “step-up” in capital gains basis does not apply if artwork is gifted or is held in a trust outside the decedent’s taxable estate.

Donating Artwork to Charitable Organizations

Donating artwork to a qualified charity can provide both charitable and tax benefits, but the size of the tax deduction depends on how the charity uses the artwork.

In general, a charitable deduction is allowed when artwork is donated. 26 US Code §170(a)(1). To claim a deduction for the full fair market value, the charity must use the artwork in a manner consistent with the organization’s charitable purpose. Treasury Regulation §1.170A-4(b)(3). For example, if a painting is donated to a museum, it should be displayed to be used for educational or cultural purposes. If the charity instead sells the artwork and uses the money to fund its programs, the IRS considers this an unrelated use. In that case, the tax deduction may be reduced, often limited to the donor’s original cost or basis in the artwork. Because of these rules, donors should keep good records and confirm in advance how the charity plans to use the artwork to maximize the tax benefit.

Exchanges of Artwork

Since 2018, artwork can no longer be exchanged under the like-kind exchange rules (also known as a Section 1031 exchange). As the rules for the exchange are now limited only to real estate properties. 26 US Code  §1031(a)(1). As a result, if artwork is now traded for another artwork, the IRS treats this transaction as if the original artwork were sold for cash equal to the value of the artwork received and then used to buy the new piece. Any profit from that exchange must be reported and taxed in the year the exchange occurs.

Angela Zhao is a tax attorney at KJMLAW Partners who advises individuals and businesses on federal tax planning and compliance matters, including the taxation of property and business transactions. Prior to joining the firm, she worked as an International Tax Associate at RSM US LLP advising multinational clients on cross-border tax issues. Angela earned her J.D. and LL.M. in Taxation from Loyola Law School, Los Angeles, and her undergraduate degree from Loyola Marymount University.

If you have questions regarding the tax considerations discussed in this article, please contact Angela Zhao.