Donating an Andy Warhol? What to Know When Seeking a Charitable Tax Deduction
Gifting appreciated artwork, other collectibles can provide donors with significant tax deductions—but they should brush up on the rules first.
By Daniel F. Rahill, CPA, JD, LL.M., CGMA |
Digital Exclusive - 2022
Andy Warhol’s “Shot Sage Blue Marilyn” sold for a record $195 million in early May 2022, making the portrait of Marilyn Monroe the most expensive work by a U.S. artist ever sold at auction. The seller, the Thomas and Doris Ammann Foundation in Zurich, said the proceeds would support health care and education programs for children worldwide. Even if your prized possessions aren’t similarly valued, your donations could still benefit others while qualifying you for sizeable charitable tax deductions and financial benefits. After all, donations of art that you’ve owned for more than one year may allow you to avoid capital gains taxes, claim a current year income tax deduction (if you itemize), and potentially reduce estate tax liability—but only if you do it right. Here’s what you need to know before making your donation and claiming it as a charitable contribution.
Donating Physical Artwork
A charitable tax deduction is based on the appraised value of the donated artwork when the recipient qualifies as a public tax-exempt organization formed within the United States. A public tax-exempt organization is generally defined as an institution that receives at least one-third of its financial support from the public. If you’re donating art to a private tax-exempt organization, like a private foundation, your deduction will be based on the lesser of its purchase price—also referred to as tax basis, which is its value when you acquired or inherited the art—or its current fair market value.
Consider this scenario: A donor inherited a piece of artwork with a fair market value of $100,000 at the time of acquisition (the tax basis). The artwork appreciates in value over time to $1 million, at which time the owner decides to contribute it to charity. If the donor contributes the artwork to an art museum (a public tax-exempt organization), and the donation meets use and other requirements, the donor should receive a $1 million charitable tax deduction. However, if the donor chooses to contribute the art to their private family foundation, the donor’s tax deduction is limited to $100,000, which was the tax basis established at the time of inheritance.
Donors seeking to maximize their charitable tax deductions should brush up on the following requirements:
- The donated artwork must be considered long-term capital property. The donor must have held the property for longer than one year in order to claim its current fair market value as the charitable deduction.
- The donated artwork must be related to the tax-exempt organization’s mission. For example, art that’s donated to a museum should be used in the museum’s collection, and art that’s donated to a university should be used to further the education of the students (e.g., displayed and used in art history lectures). Failing to meet this test would result in a deduction based on the artwork’s purchase price and not its fair market value. Further, if the intent at the time of the donation is for the tax-exempt organization to sell the artwork, the donation won’t qualify for a tax deduction under the related-use test.
- The tax-exempt organization must keep the donated art for three years. If the tax-exempt organization receiving your donation sells the artwork within three years, and its value is worth more than $5,000, the allowable charitable deduction will revert to the artwork’s purchase price instead of the appraised fair market value. In other words, it’s advised that the donor secure a promise from the beneficiary not to sell the artwork within three years of its donation to preserve the fair market value and ensure the charitable deduction is maximized.
- The donor must obtain a qualified appraisal. A donor must file IRS Form 8283, Noncash Charitable Contributions, with their tax return if the amount of a noncash donation is more than $500. To qualify for a fair-market-value tax deduction for noncash contributions worth more than $5,000, a donor must also obtain a qualified appraisal, which must be attached and signed by both the appraiser and the tax-exempt organization receiving the gift. For artwork contributions worth more than $20,000, the appraisal report must also be attached.
- The donor must be an art collector or investor. If you’re an art dealer or an artist, you’re not entitled to take deductions on charitable donations of artwork.
For artwork donors who itemize their deductions, annual limitations also need to be considered. A fair-market-value tax deduction is allowed for up to 30% of adjusted gross income (AGI), assuming the donors meet the long-term holding period, use, and other rules described in the list above. For donations to private foundations, the charitable deduction is limited to only 20% of AGI (and would be based on the lesser of the fair market value or tax basis). Any excess deductions not allowed because of AGI limitations will be carried forward for five years.
For example, using the scenario described above, let’s assume the donor has an AGI of $1 million and decides to move forward with donating the inherited artwork that now has a fair market value of $1 million to a qualified charity. The donor is allowed a $300,000 charitable deduction in the tax year it was donated (2022), while the remaining $700,000 will carry over for five years. If the donor’s AGI remains the same in the years ahead, the donor will receive $300,000 deductions in 2023 and 2024 and $100,000 in 2025.
Other tax planning strategies could apply if the donor’s charitable deduction is limited by AGI in the current year. In this scenario, the donor can elect to reduce the charitable deduction to the tax basis of the donated artwork. By making this election, the deduction limit is increased from 30% of AGI to 50% of AGI. Such an election might be preferable if it allows the taxpayer to deduct a greater percentage of AGI and the artwork’s fair market value and tax basis are fairly close.
Interest in donating artwork in the form of non-fungible tokens (NFTs) has increased dramatically in recent years. Given their unique, digital nature, and the lack of IRS guidance on NFTs, both donors and recipients face several tax uncertainties.
The most obvious challenge now is that NFTs aren’t easily convertible into currency, presenting unique challenges to recipients of donated NFTs. An exception would be an art museum that would make the NFT part of its collection. An appreciated NFT with a long-term capital gain holding period could be donated to an art museum if the donor is able to receive a qualified appraisal (required for donations of more than $5,000). However, this could prove difficult as each NFT is unique, and the NFT marketplace is still relatively young, making comparisons to similar sales between willing buyers and sellers almost impossible. As a result, rather than contributing NFTs directly to charities and other tax-exempt organizations, many donors are selling their NFTs, with all or a portion of the proceeds then being donated to the desired tax-exempt organization, which is a more straightforward way of making a charitable contribution and establishing a charitable deduction.
For charitably minded art collectors, donating artwork can be incredibly rewarding for them and the beneficiaries. But when it comes to reaping the rewards of those donations, and maximizing the tax and financial planning benefits, donors can’t brush off the need to be strategic about when and where they make their donations.
Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Management. He’s also a former chair of the Illinois CPA Society Board of Directors and is a current board member of the American Academy of Attorney-CPAs.
This information is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained.