The Art of Avoiding Taxes

At its highest levels, the art world is international. An artist may come from country A, an artwork’s owner from country B, the gallery, dealer, or auction house from country C, and the buyer from country D. Add art fairs and exhibitions to the mix, and you end up with numerous international transactions and shipments. Which can mean taxes and government restrictions.

But domestic sales also create tax bills. With phenomenal dollar amounts in play, it is not surprising that ultrawealthy players have come up with strategies and tricks, legal and illegal, to exploit loopholes and avoid taxes (take legitimate, legal action to reduce them) or evade taxes (illegally fail to pay them). Here are several.

Freeports

Let’s say an American we’ll call Mr. Buyer buys a million-dollar painting. If he buys it abroad and ships it home, the purchase must be declared when clearing U.S. Customs. Art is duty free, so a fee up to about $500 is all that the U.S. Government collects. However, the state where the painting was delivered can request import information from Customs, and collect state sales tax on the purchase.

But, if Mr. Buyer never ships the painting to the U.S., then no state tax is due. The effect is magnified when other countries are involved because many of them have customs duties and value-added taxes (VAT). If Mr. Buyer buys a painting in the U.S., he can have it shipped abroad to avoid sales tax.

Photo by Pickawood on Unsplash

So someone created a safe place to receive and store paintings to avoid taxes and duties, the first of many “freeports.” They are secure warehouses situated next to seaports and airports in tax free zones all over the world. To protect valuable artworks and other collectibles (like wine), the best warehouses are temperature and moisture controlled, earthquake and bomb proof.

Switzerland, known for neutrality and fine watches, is also known for secrecy, as in Swiss bank accounts. Well, secrecy also applies to freeports in places like Geneva. The details of what is being stored, and by whom, are not known. And as long as the painting sits there, Mr. Buyer pays storage fees but no taxes or duties. This also means he does not get to enjoy the painting, evidence that he bought it as an investment, not to look at it. The effect can multiply if a subsequent buyer keeps the painting in the same freeport.

In a variation of this practice, some billionaires have shipped, pun intended, art purchases to their superyachts. (Remember Salvator Mundi?)

Fake Deliveries

State and local sales and use taxes are significant on high-priced artworks, so here’s a dodge to evade those taxes. Ms. Buyer lives in New York and buys a painting from a local gallery; the gallery arranges shipment to her second home in Montana. New York collects no sales tax on this out-of-state sale.

Montana has no use tax (tax on an item or service bought outside the state but used within the state). Someone signs for the delivery in Montana. Without the box being taken off the truck, the painting is transported back to Ms. Buyer in New York. The gallery and she now have a record of it being delivered to Montana, and she does not report it going back to New York. No sales tax; no use tax.

Empty Boxes

A more brazen way of avoiding sales and use taxes was shipping boxes that were supposed to contain art, but which were actually empty. This created documentation falsely showing where the artworks went. These were known as “tax boxes.”

Donating to Make Money

Mr. Investor buys a painting he loves and enjoys it in his home for a number of years. Then he donates it to a museum. Let’s say the painting more than tripled in value over those years. He gets a charitable deduction for the new appraised value of the painting instead of what he paid for it. This means he saves more money on income taxes than he paid for the painting, and he got to keep it on his wall for years.

With no cash changing hands, the higher the appraised value, the more the donor and the museum benefit. This puts pressure on the appraiser to suggest the higher end of a range, which could result in inflated values across the art market. And the donor gets to have his name next to the painting in the museum forever.

You’ll Have to Wait, Uncle Sam

Like-kind exchanges, also known as 1031 exchanges, allow  taxpayers to postpone paying taxes on profits made when they sell an asset at a profit if the proceeds are used to buy a similar asset for investment purposes. This tax method began in the 1920s to benefit farmers with real estate, but it also applied to art until 2018. Let’s say Ms. Art Collector bought a painting for $100,000 and sold it for $500,000. If she bought a new painting for $500,000 within 180 days, she delays paying capital gains tax on the $400,000 profit until she sells the second painting, which might never happen. She might donate the painting, or she might die before selling. As morbid as that sounds, I mention it because exchanges became an estate planning tool, a way to transfer wealth.

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I simplified the scenarios above because tax laws are complicated. There are rules and limitations of all kinds: the percentage of income that can be deducted for a donation, how long an artwork must be held, etc.

Some of the examples only work if the artworks significantly increase in value. There are no guarantees, so the buyers’ money is at risk. But wild increases happen so often at the highest price levels that these strategies are commonly used by the uberwealthy.

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Yesterday, there was a Forbes article by Ollie A. Williams titled “Art Market Goes Into Overdrive As Wealthy Up Their Spending By 42%.” Williams reported, “The average spend in the first half of 2021 reached $242,000.”

Last weekend, I walked through a downtown art fair and bought a $10 print from an art student displaying her work on a sidewalk table.

How does her part of the art world connect to the art world of the wealthy? Let’s just say we have a lot to talk about in future posts. Stayed tuned.

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