On January 1, 2015, the gift and estate tax exemption increased to $5.43 million per person and to $10.86 for a married couple. Artists who hope to take advantage of the increased exemption face unique challenges when making gifts to family and friends of visual art they have created. Although specific situations can differ widely, the general principles to consider when making such gifts are described below.
Generally, the donor’s income tax basis carries over to the gift recipient and is increased by any gift tax paid. Because visual art is ordinary income property in the hands of the creator, the donee of a gift of a work of visual art from the creator receives the artist’s income tax basis. The donee will recognize ordinary income if he or she chooses to sell the gifted item, and the proceeds will be subject to tax at the donee’s ordinary income tax rate.
To avoid this result, many artists consider waiting to gift works of visual art they have created until death. The beneficiary of a testamentary gift of visual art from the creator receives the gift with a “stepped-up” basis to the art work’s fair market value on the date of the artist’s death. Additionally, because the beneficiary is not prohibited from holding the work as a capital asset, the beneficiary’s sale of the work of visual art would receive capital gain or loss treatment. Whether the long and short capital term gain tax rates are preferential to the taxpayer’s ordinary income rate will vary. For high income taxpayers, the long-term capital gain tax rate may be lower than the beneficiary’s ordinary income tax rate. Of course, the donee’s basis is less of a consideration if the donee does not intend to sell the work.
An artist may favor making a lifetime gift of visual art if the gift qualifies for the annual gift exclusion ($14,000 in 2015) and thus, would not be subject to gift tax. Further, if the artist has an estate that will be subject to estate tax, there may be advantages to gifting art during the artist’s lifetime so that the value of the visual art (and all post-gift appreciation) is not included in the artist’s estate (and subsequently subject to estate tax).
On the other hand, an artist may opt to delay making gifts until his or her death if the artist wishes to use and enjoy the visual art for the remainder of his or her life. Moreover, there may be limited estate and gift tax advantages to gifting the visual art during the artist’s lifetime if the artist has already used his or her lifetime exemption amount or if the artist’s estate is not expected to be subject to estate tax upon his or her death.
Applicability of the legal principles discussed may differ substantially in individual situations. The information contained herein should not be construed as individual legal advice.
