Many individuals have substantial investments in collectibles, such as art, stamps, coins, autographs, books, maps, baseball cards, glassware, antiques, gems, jewelry, or wine. The category is broad and does not distinguish between the motive to be a dealer, a hobbyist, or a serious investor—although the tax treatment is different for each. CPA financial planners can assist all such individuals, though the advice can vary.
Dealer, Investor, or Collector
A dealer is someone in the trade or business of buying and selling collectibles. An investor is someone who buys and sells with the view toward gains but is not in business as such. A collector is someone who collects as a hobby with no profit motive. Many times, there is no clear distinction between dealer and investor, or investor and collector, other than the frequency of transactions, promotional activities, and the intent.
Investors and collectors can make donations of appreciated items and take a deduction for their fair market value without recognizing the gains under the right circumstances (explained below). Dealers are subject to the “deduction of inventory to a charity” rules. There are limitations, which are covered below.
Investors can deduct their expenses as a miscellaneous itemized deduction, which does not result in substantial tax benefits for many people due to adjusted gross income (AGI) limitations and the alternative minimum tax (AMT). Alternatively, some investment costs could be added to the basis of the collectibles; investors can treat losses as capital losses subject to those limitations.
Dealers are operating a business, regardless of the nature of the products handled. Gains will be ordinary income, and losses will be treated as any business loss. Capital gains treatment is not available for the sale of inventory items.
Hobbyists cannot deduct any losses or expenses. If they can qualify as investors, then investing expenses can be deducted and gains and losses treated as capital transactions. If a hobbyist engages in some sales transactions and reports this as a dealer, he might be subject to the hobby loss rules, which could vitiate the losses. He could also lose out on the capital gains and donations of appreciated property to a charity benefit. In these cases, collectors need to consider the benefit of possible current tax losses to the longer-term capital gains benefits.
Note that investors and collectors pay sales or use tax when they acquire collectibles; dealers do not, because they are purchasing inventory for resale.
When collectibles owned by investors and hobbyists held for more than one year are sold, the income is taxed at a 28% capital gains rate, regardless of the individual’s other income or AGI. There could also be a 3.8% net investment income tax, depending on the individual’s AGI. Losses would not be deductible unless the seller is an investor; the capital loss limitations would then apply. Dealers are not allowed capital gains treatment.
Contributions to a Charity
Investors and collectors can make donations of collectibles to charities and receive a deduction for the fair market value, provided the charity uses the collectible in connection with its activities (the “related use standard”) and does not dispose of the item within three years of receipt. Furthermore, the income is not recognized for tax purposes.
There are other provisions for charitable deductions:
- Each individual item with a value over $5,000 must have a written appraisal by a certified appraiser in accordance with IRS regulations.
- The appraiser and the charity must sign the donor’s IRS Form 8283, Noncash Charitable Contributions.
- The organization must be registered with the IRS as a charity.
- The organization must certify that it will not dispose of the gift within three years of receiving it and that there are no use restrictions by the donor.
The appraisal must be done no earlier than 60 days before the gift is made and must be received by the donor no later than the return’s due date (including extensions). If the value of the collectible is over $500,000, the appraisal must be attached to the tax return. If multiple gifts of similar items are made that are over $5,000 in the aggregate, the authors suggest obtaining a certified appraisal. One of the requirements of the appraisal is that the items be examined by the appraiser, so this generally precludes an appraisal done after the gift has been made.
There are various other rules for art, and it is suggested that the instructions to Form 8283 be reviewed prior to advising an individual on how to handle donation of art or collectibles. For contributions of art with an appraised value of $50,000 or more, the taxpayer can request a Statement of Value from the IRS, which charges fees for this. As with any valuation, there are substantial IRS penalties for misstatements.
When a charity provides a receipt for a collectible, it acknowledges receipt of the items but does not provide any value amount. The valuation is the donor’s responsibility.
Many charities will almost immediately put gifts of collectibles into auction; when this occurs, the charitable deduction is limited to the donor’s basis, not the appreciated value. For example, assume a painting that cost $10,000 is valued at $100,000 and is donated and then sold at auction for $100,000; the charity receives $85,000 after auctioneers’ fees. If the charity sells the painting within three years, the deduction is limited to $10,000; if sold after three years, the deduction will be $100,000. The $15,000 auction fee is a cost of the sale and does not factor into the amount of the deduction. Note that if the painting is sold for more or less than the $100,000 appraised amount, the deductible amount would still be $100,000, which was the value at the date of the gift.
Gifts of self-created items (such as paintings) are limited to the donor’s basis, regardless of the value and the charity’s holding period. Thus, a painting with an appraised value of $200,000 where the materials cost $350 would generate a $350 tax deduction. The charity would record $200,000 as a contribution in kind.
A person who buys the collectible at auction or from the charity would be entitled to a deduction to the extent of the excess she paid over the fair market value. In the earlier illustration, if the fair market value were $100,000 and the bidder paid $125,000, her deduction would be $25,000. The charity is required to give a receipt noting the $25,000 donation; the $100,000 is considered a quid pro quo benefit, even if the charity netted $85,000 after the auctioneers’ fee.
The related use standard is applied in order for the donor to be able to get the best benefit of the contribution; this means that the charity must use it in its activities. For example, an art museum must add it to its collection and have it available to be displayed. A painting donated to a hospital can be placed on the wall of a waiting area, solarium, boardroom, or similar public place. A library or school could place it on one of its walls, or be used as a teaching aid. Failure to adhere strictly to the rules could cause the deduction to be lost.
Dealers that contribute collectibles out of inventory can deduct the smaller of the fair market value on the day of the contribution or its basis. There are special rules to calculate the basis, which are not covered here.
There is an overall limitation for deductions for charitable contributions, which is 50% of AGI, but in some cases 20% and 30% limits may apply. Furthermore, contributions over the annual limits can be carried forward for as much as five years.
There are also special rules for contributions of partial interests in property that should be reviewed prior to advising individuals considering such a donation.
Deductibility of Appraisal Fees and Other Costs
The costs of appraisals of donated property are not deductible as charitable deductions, but can be claimed as miscellaneous itemized deductions (similar to the other costs of preparing a tax return) subject to AGI and AMT limitations. For investors, the costs of appraisals and other items such as insurance, storage, subscriptions, and travel in connection with purchases would be deductible as miscellaneous deductions or, depending upon the nature of the expenditure, possibly added to the basis of the property. Collectors cannot deduct any such items.
The authors believe that costs of shipping a collectible to a charity are deductible as a charitable contribution, as with out-of-pocket costs in connection with services to a charitable organization.
Sales by an Estate
Collectors take great care in assembling and organizing their collections, but very few leave any instructions on how to dispose of their collections after their death. Depending on the value, type, and quantity of items, a collection might be sold outright to a dealer or given to an auctioneer. Names of at least two dealers the collector knows and two suitable auction houses should be provided by the collector along with instructions; at a minimum, two estimates should be obtained. Any sales by an estate are not subject to capital gains taxes, but the value should be included in the estate. If no sale is consummated within nine months, an appraisal will need to be obtained. Even if a sale is consummated, it might still be advisable for the executor to obtain an appraisal. An alternative to a sale is to have the collection donated to a charity, but this cannot be done unless this direction is included in the will and an appraisal obtained.
A Variety of Considerations
Individuals with collectibles require advice from CPA financial planners. There are income and estate tax and charitable donation issues, as well as important and strict compliance rules. There is also the treatment of ongoing costs and gains or losses when disposed of. This area, as with any complicated tax issue, needs to be researched for the most recent rulings and cases when transactions are contemplated. Individuals should be made aware that the planner should be consulted prior to any transactions—afterward, in most cases, would be too late.