Art Flippers and Private Museums Could Suffer Under the Republican Tax Plan
The proposal has set off alarm bells in certain corners of the art world.
The US House of Representatives unveiled an ambitious tax plan last week that many experts say would largely benefit corporations and the wealthy. But a few of art collectors’ favorite loopholes have been tightened in the process. Although lawmakers emphasize that the bill is a long way away from final, the proposal has set off alarm bells in certain corners of the art world.
The plan could be bad news for two kinds of elite collectors: those who are constantly buying and selling art and those who have set up private museums to house their holdings.
Republicans’ proposal seeks to tighten an obscure and complex provision in the tax code that allows investors to immediately avoid capital-gains tax by using the proceeds from the sale of a piece of property to purchase another, similar piece of property within a short period of time—a handy mechanism for art flippers.
Although the rule is most commonly used in pricey real estate transactions, it became wildly popular among art collectors during the recent market boom, not only because the value of art skyrocketed to unprecedented levels, but also because art remains one of the few assets that incurs the highest capital gains rate (28 percent).
The Republicans’ new proposal limits the use of these “swaps”—called “1031” or “like-kind” exchanges—to real estate. That means that collectors who once relied on the tool will be out of luck (The Obama administration also sought to clamp down on the practice.)
The plan also targets private museums by specifying that these increasingly popular institutions must meet a certain standard in order to qualify for the full tax benefits they are used to enjoying. The plan states that museums must remain open during normal business hours for at least 1,000 hours each year to qualify as tax-exempt foundations.
If both rules make it into the final tax plan, they would go into effect after December 31.
No More “Swaps”
The elimination of the “1031” exchange rule is likely to be a bigger blow to the art market than the revised museum guidelines. In an email sent to subscribers this morning, art market commentator Josh Baer said the revised 1031 policy “could have extreme consequences for the art business.” But there may be “a flurry of activity before the end of the year to get deals started” before the rule kicks in, he added.
“There is no question that 1031 exchanges have been an incentive, if not the raison d’etre, for many art transactions,” attorney and art law expert John Cahill told artnet News. “We will be keeping a close eye on the tax bill as it makes its way through Congress. While we don’t think it will cause an art market crash if it passes, we do believe that some transactions will be less likely to occur or will be structured in a different way as a result.”
In a call with investors on Friday morning, Sotheby’s COO Adam Chinn called the overall tax reform bill something of “a mixed bag.” He said the proposed restrictions on 1031 exchanges would be “a mild negative for the market” in the long term, but would also be likely to create “a velocity of transacting” in the short term, while the existing rule remains in effect.
The change would not just affect art collectors. The tax-deferral strategy has been a favorite of individuals and businesses that trade other kinds of property as well, including tractors, airplanes, and rental cars. Some experts say the art world can expect an army of business allies to rally to keep the change from going ahead.
Others wonder whether lobbying will move the needle. Attorney Thomas Danziger told artnet News: “Although it is hard to predict the likelihood of passage of this particular provision, I find it difficult to believe that Congress would have much sympathy for a provision that is perceived as principally benefitting wealthy hedge funders and other investors.”
Indeed, in order to even be eligible to execute this particular tax-savvy strategy, an individual must qualify as an art “investor,” not merely a collector—which means his or her primary reason for owning art is to profit from it, not to enjoy it.
The 1031 exchange, therefore, only applies to a very rarefied slice of the art market. “It’s a pretty hard threshold to reach for an individual collector,” said Stephen Urice, a professor at the University of Miami School of Law.
Private Museums Under Scrutiny
The tax reform bill also appears to take aim at private museums. It specifies that any museum must remain open for at least 1,000 hours a year in order to qualify for full tax benefits. Under the current law, founders of private museums can deduct the fair-market value of art (as well as cash and stock) donations to their own museums, which allows them to reduce their taxable income by as much as 50 percent each year—even if their institutions are open by appointment only for just a few days each week.
As the value of contemporary art has risen, the popularity of private museums has increased. The US has 43 private art museums, the second-most of any country, according to a survey by Larry’s List. But these institutions have also come under scrutiny in recent years from those who say they are not accessible or beneficial enough to the public to justify the sizable tax benefit enjoyed by their founders.
In 2015, the chairman of the Senate Finance Committee, Orrin Hatch, sent a letter to 11 private museums asking for information about hours, accessibility, and attendance.
In a summary of his findings sent to the Internal Revenue Service the following May, Hatch wrote: “Despite the good work that is being done by many private museums, I remain concerned that this area of our tax code is ripe for exploitation.” (A spokesman for Hatch did not respond to a request for comment on the new proposal or whether it is expected to appear in the Senate’s equivalent tax plan.)
The proposed change might present a hurdle for a few institutions, but it is unlikely to radically alter the private museum landscape—at least in the short term. One of the institutions on Hatch’s list cited as having among the narrowest opening hours, the Linda Pace Foundation in San Antonio, Texas, would still meet the new standard. (The institution is open 25 hours a week, or 1,300 hours a year.)
Jason Kleinman, a tax expert and partner at the firm Herrick Feinstein, notes that the process of setting up a private museum is already so onerous that the new rules are unlikely to be a deterrent. “All that requirement could do is increase the financial cost to someone of running a museum,” he said.
Any problems created by the new standard are likely to surface further down the line, Kleinman noted. “What happens 30 years after the donor dies and the endowment is running down? Do they have to stay open the same number of hours per year?”
Some experts argue that the tax plan is, on balance, likely to help the top one percent far more than it hurts them. The plan proposes to cut the corporate tax rate from 35 percent to 20 percent and reduce the estate tax to make it easier for multimillionaires to leave large sums of cash to their children. So even though small loopholes might be closing, the richest Americans are likely to be better off under the new plan than they were before.
Nevertheless, the devil is in the details. “Sometimes these small shifts can really annoy people—especially the wealthy,” Urice said. Broader changes to the tax code are one thing, but it’s another when new regulations target “something that’s closer to the heart.”
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