Yes, there are limits to the tax-deductibility of donations of fine art by the artist. But how did I even come up with this topic? Many thanks to my seatmate on a recent flight who posed this hypothetical question, worthy of a Harvard Law School Professor: if an artist sells her painting for $1 million, can she then paint an identical copy, donate it to a charity, and claim no income for the tax year, on the assumption that the value of the copy is $1 million (because that’s what she sold the original for)?
It may not surprise you, but the answer is “no.” But let’s have some fun looking at why (Tax is Fun could be my motto, after all).
The Simple IRS Math of Donating a $1 Million Painting
The sale of the original painting realizes $1 million for our artist. Let’s assume she earns nothing else that year, and has no deductions, for the ease of argument. Her adjusted gross income (AGI), line 11 of form 1040, will be $1 million.
Our artist may only deduct the charitable contribution after reporting her income because the annual limit on charitable deductions is determined by the amount of income. The tax code limits charitable donation deductions to 60 percent of AGI. Thus, our hypothetical artist can, at best, claim a $600,000 charitable donation deduction, and will be taxed on $400,000 of income.
The Complicated IRS Math of Donating a $1 Million Painting
To qualify for even this attenuated deduction, our artist will need to jump through some hoops. Donation of property worth more than $5,000 requires Form 8283 and a qualified appraisal. Art prices are based on authenticity and scarcity; the second, copied painting may not be worth the $1 million that our artist pocketed from the original painting. I expect that the IRS would find an appraiser who uses some strange theory to argue for an even lower valuation, cutting the value below $600,000 and forcing our artist to pay even more tax. Even if the IRS loses this argument, she would need to pay an attorney (please call me!) to defend the valuation, meaning she has a strong incentive to claim the value of the painting is substantially less than $1 million so that she doesn’t trigger an audit. But, our artist would never get to this point because…
The Painting is “Ordinary Income Property” and thus Only Materials Cost is Deductible
Actually, this scenario won’t happen, because another section of the law denies the deductibility of the painting as a charitable donation altogether, appraisal or not. Our artist engages in the business of producing and selling art. Thus the painting is a piece of “ordinary income property” for the artist. For such property, the code limits the deduction to the donor-taxpayer’s basis in the property: “basis” being the amount paid to acquire the property. Of course, the artist only paid for materials, even though she spent unpaid time and effort on the painting. To Congress and the IRS, she donated only the materials that went into the painting; what she did with those materials is an unrewarded donation to the charity.
Do you have a real or hypothetical tax-related question? Call me and let’s nerd out on how to answer it!
July 14, 2023