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It's tax season in the United States, and the art market is one of the many ways rich people game the system to save billions of dollars in taxes each year. Here's how it's done.

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Every year, rich people use art to avoid billions of dollars in taxes in the United States.  How?  Well, if you're a billionaire looking to minimize your tax burden, prepare for some life hacks, and if you're anyone else, prepare to be astonished and possibly nauseated by what happens when tax deductions are combined with the government's failure to regulate a market.

We all know art is a commercial product, just like toothbrushes, cars, or Art Assignment t-shirts, and most art purchases are straightforward.  In the US, you buy an artwork and you pay whatever it costs plus the state's sales tax.  If you're buying out of state, then sales tax isn't charged but in most cases, you're supposed to pay a use tax to whichever state you receive it in.  In 2017, there was $63.7 billion in total art sales globally and that's not because the seven billion of us here on Earth each bought $9 artworks, although that is a nice thought.

Most of this money is spent by extremely high net worth individuals who buy art from the primary market, such as galleries where works are sold for the first time and also the secondary market like auction houses that resell works at increasingly unbelievable prices.  Seriously, last year, this admittedly astounding Leonardo Da Vinci painting sold at auction for $450.3 million and this painting by Peter (?~1:27) who is well regarded in art circles but many people have never heard of, sold for $28.8 million.  

Okay, so let's imagine two scenarios.  Scenario 1: You're a wealthy collector from New York who actually likes art.  You buy a painting from the primary market for $1 million.  You take the sales tax hit of about $88,000 and hang it in your home.  You enjoy it greatly for many years while the value of the painting steadily creeps upward, thanks partly to your good luck and/or good eye for art and also partly due to the support of the artist's gallery which works hard to get the artist's work shown in museums and also increases prices through sales and strategic auctions.  

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All the while, the art museum you support has been courting you and has let you know that they would be happy to take this work off your hands, should you wish your painting to join their collection and reach a wider audience.  This sounds pretty good and since you've owned the painting for more than a year, you can donate the painting to the museum and claim a charitable income tax deduction equal to the work's current fair market value.  You hire a qualified independent appraiser who researchers sales records and provides you with certified documents that say your painting is now worth $5 million.  Cool.  

You get advice from your accountants because you have more than one and they tell you that if you give the painting to a museum, you can deduct its appraised value from your taxable income as long as the deduction is less than 30% of your income.  So if you make $17 million a year and you donate the painting, your taxable income goes down to $12 million a year, but say you make, for instance, a paltry $3.3 million a year.  You can only deduct 30% of that, but fear not, you can spread the tax deduction over five years, so you let the museum know you'd like to give it to them, and they say thanks and put your name on the wall label next to the painting when they display it, which is nice.

At the end of it all, you've saved at least around $1.75 million in taxes, a pretty good return on your million dollar investment and the museum is able to share a new artwork with the community, which is nice since art prices are so high museums can't afford to buy it directly anymore.

Scenario two is that you're a wealthy person from New York who doesn't actually like art that much, but you've realized its investment potential.  You buy a $1 million painting and you don't care about having it in your home, so you ship it directly to a free port, which are giant climate controlled warehouses in tax free zones.  As long as it's there, you don't have to pay tax on it. 

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The art stays safe in the dark, huddled next to all the other lonely caged luxury goods and you keep earning money while the value of the artwork increases for the same reasons as before.  Plus, maybe you loaned it out to museums a few times, which bolsters its exhibition history and makes it more theoretically valuable.  After ten years, you get it appraised and you learn of its $5 million valuation.  

Alright, you say, let's try to sell this.  You talk to the dealer who sold it to you and maybe they can convince another client to take it off your hands directly.  Maybe that client even has art stored at the same freeport and they broker a deal between the two of you where the art changes theoretical hands but never actually moves out of the freeport.  Nobody pays sales tax, you've made a sweet profit, and the money you made is taxed as capital gains, which means your tax rate is lower than it would be on income.  

Or you decide to take the painting to auction, at which you point you have to take the sales tax hit you avoided before and also pay fees to the auction house.  It goes up for sale and because an appraised value isn't its actual value, it could not sell at all, or it could sell for anywhere between its reserved price, the minimum price they've agreed with you they will sell it for, and who knows how much?  Because auctions aren't regulated, they're famously subject to manipulation.  Maybe other collectors of that artist's work bid the price up, or maybe galleries buy works through proxies to maintain the value of other works.  We don't really know, but we do know that these results are reflected in future appraised values, which are then used to determine other collectors' deductions and again, the profit you make from the auction is taxed at that lower than income capital gains rate.  

Both of these collectors are taking risks.  There is no guarantee the art you buy will increase in value, and there's also a possibility you won't find a buyer when you want to sell the work, but the truth is this: the number of billionaires in the world is rising and an increasing number of them are gaming the art system to save a fortune in taxes.

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As for how I feel about all this?  (puking sounds)  We don't talk about the art market on this channel very much for a reason.  For me, it's the least interesting part of the whole art endeavor, but it's what media outlets love to report on and heck, you're still watching.  Art is a commodity but it's not merely a commodity.  It has a monetary value that can sometimes but not always be quantified, but it also has another kind of value that is less measurable.  

When a huge number gets attached to an artwork, you might look at it and think, whoa.  That must be a really important painting.  I better look closely and figure out why, but most of the time, you quickly move on to whoa, there's no way this application of pigments mixed with oil on fabric stretched over a wooden frame can live up to this kind of evaluation.  It can still be a great painting, but it becomes increasingly difficult for it to meet the expectations created by the extraordinary number that's floating around in its ether.

These market conditions are fantastic for uber-wealthy collectors for a very small number of artists anointed as good bets and only a handful of mega, major conglomerate galleries.  Emerging and mid-tier galleries who might actually be focusing on cultivating young or under-recognized talent and thinking outside of market forces about what makes for good art, in general don't have access to these collectors and very many good artists are not represented by galleries and can't even approach this level of the art world.

Museums do benefit from being supported by the wealthy and being given works from their collections, but museums also find themselves in a terrible bind, as the deductions that fuel donations have inflated art prices way beyond their reach and they also run the serious risk of reflecting only the tastes of their donors and trustees rather than the purported best of what's actually around.  There is some trickle-down effect where wealthy collectors fund non-profit arts initiatives that have nothing to do with their market interests and there is, of course, lots of great art happening around the world that is completely unrelated to freeports and auction houses, but this is a reality we must grapple with as art's role as financial capital has become more and more influential, it's bleeding out to affect its life as social and cultural capital.

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It's affecting what kind of art gets made, shown, and canonized in museums.  I mean, it's been reported that there are 1.2 million artworks currently in a dark, locked freeport in Geneva, Switzerland.  It's hard to see who benefits from this except for the richest people in the world and the downside of this system is becoming and will continue to become increasingly apparent.

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