Last month the U.S. Congress made several changes to the tax law. What they did and what they didn't do have major ramifications for the photography and art markets.
First what they didn't do. The Congress failed to lower the capital gains tax on artwork from 28 to 20% and failed to pass legislation that would allow artists to donate their own work at appraised value instead of only at cost of materials. Capital gains treatment generally comes into play after an investor has held on to an asset for at least a year. If you hold the asset for less time, your ordinary income tax rate would apply.
The failure to achieve a lower capital gains treatment means that artwork as an investment is at a severe disadvantage to other financial investments, such as stocks or bonds, where the capital gains was lowered some time ago to only 15% for the average tax payer (talk to your accountant about your specific situation, which can vary) but artwork and collectibles remained at the rather steep 28%. An attempt to lower the capital gains tax on artwork to 20% failed, not surprisingly, given the total lack of action on the part of art and photography collector and dealer groups. Without the pressure of consequences (loss of votes and financial support), Congress rarely gives away tax dollars. I saw no initiatives taken by any group to even petition their local representatives by letter and/or email, let alone begin a lobbying effort. This was one more lost opportunity for this market.
Meanwhile, artists/photographers fared no better. Proposals to allow artists to donate work at appraised value, instead of only at cost of materials, failed to go anywhere. And, again, one wonders what happened to the various associations of photographers and artists, which were also missing in action on this important issue to their members.
Worse for museums was a tax law change that effects a practice known as fractional or partial giving, which has been a popular method for collectors to donate to museums. The fractional gift practice is one where an artwork is "donated" but can remain largely in the owner's possession often until they die. Some critics charge that the practice has been abused by some wealthy donors, many of whom received upfront tax deductions for works that will not appear in museum collections for decades. The changes to the tax law apply only to fractional gifts made after August 17, 2006, after the bill was signed into law by President Bush.
With a fractional gift, a donor gives a percentage interest in a work of art to a museum or charity. The donor gets a tax deduction for an equivalent percentage of the work's value. The museum gets the right to hold the work for a portion of the year that is equivalent to the percentage of the work given.
The collector can continue to hold the art the rest of the time, but in practice many museums have waived their right to possess pieces at all except when they needed them for exhibitions. Donors can then make further fractional gifts in subsequent years, helping to spread out their tax deductions over a longer period while still making use of the gifted work. For museums, works that start out as fractional gifts almost always become full donations eventually.
Several tax information sources claim that the new law creates enough disincentives to effectively end the practice, while actually not banning fractional gifting.
The previous law on fractional gifts gave donors two major advantages: 1.) If the art increased in value, the tax deductions from each subsequent fractional gift went up accordingly. And, 2.) the other advantage was that donors could continue to enjoy the works privately for a long time, sometimes even until they died.
Under the new law, the value of a work of art is set at the time of the first fractional donation, and the donor can no longer get larger deductions for later fractional gifts if the art appreciates. But if it declines in value, the taxpayer gets a lower deduction for future donations. The new law also says that museums must take "substantial possession" of the work of art following the initial gift and receive full ownership and possession of the object within 10 years.
Most sources say that this will discourage donations, particularly from younger donors, since collectors will now hold on to works as long as possible to maximize the potential tax benefit when they actually make the donations.
Under the new changes, there could also be significant estate tax penalties if donors make fractional gifts and then die while the work is still in their possession.
Museum directors told the New York Times that without fractional giving, more works of art will ultimately end up in estates, where they are far more likely to be sold off to private collectors than to art institutions.
Museums view fractional giving as a vital method to attract valuable donations and build long-term relationships with important and rich collectors.
According to the New York Times, about 80 percent of new acquisitions at American museums now come through donations. Major museum directors interviewed for the Times story on this subject estimate that fractional gifts account for only about 10 percent of the donations, but that those works are often the most valuable and historically significant pieces. Without such donations, many museum directors say they worry that their ability to build collections will be severely crimped.