Art

Want to Avoid U.S. Taxes on $80 Million Warhol? Buy More Art

"Turquoise Marilyn," 1964, by Andy Warhol. Chicago collector Stefan Edlis sold the work to billionaire Steven A. Cohen eight years ago for $80 million. Source: Sotheby's via Bloomberg

Chicago plastics manufacturer Stefan Edlis faced more than $20 million in U.S. capital gains taxes by selling his Andy Warhol painting to billionaire Steven A. Cohen eight years ago.

He paid zero. Half of the proceeds from the $80 million sale of Warhol’s 1964 “Turquoise Marilyn” were tax exempt as an asset of Edlis’s private foundation, he said. The other $40 million was used to buy more paintings, which was permitted under a long-standing provision in the tax code that allows investors to defer capital gains by buying similar property of equal or greater value.

Wealthy collectors are saving millions of dollars with this tax break by rolling profits from the sale of artworks into buying more art. These so-called 1031 exchanges have increased in popularity as art prices have surged, attracting the scrutiny of lawmakers in Washington who are calling for the repeal of the provision on collectibles.

Edlis, who along with his wife, Gael Neeson, gave 42 artworks valued at about $400 million to the Art Institute of Chicago last week, said he has used the 1031 exchange for most of his sales and acquisitions of art during the past 10 to 15 years.

“It is a great tool for upgrading, concentrating or a change of focus,” the 89-year-old Edlis said in an e-mail.

Buy Boat?

The Edlis-Neeson Foundation has given $28.9 million in grants to cultural institutions and nonprofits, including the Whitney Museum of American Art, since its inception in 2007 to 2013, the last publicly available figures, according to its tax returns.

“What would I do with the money?” he said in a telephone interview. “Buy a big boat? Buy an island in the Caribbean? I am an art investor so investment in art was the most logical thing. Almost 90 percent of my net worth is in art. I’m over-invested.”

Unlike donations to museums and private foundations, which allow collectors to receive tax deductions on the full market value of art, these like-kind exchanges are the only mechanism available to American collectors who want to reinvest in the art market without immediately paying taxes, said Diana Wierbicki, partner and global head of art law practice at Withers Bergman LLP.

“It’s a very good financial tool for extending the value of your art holdings,” said Dean Valentine, a Los Angeles-based collector who said he has done several 1031 exchanges in the past 18 months. “Whatever profit you make can be reinvested in art instead of going down the government drain.”

Horses, Planes

Since 1921, section 1031 of the Internal Revenue Code has enabled investors to roll profit back into their businesses by deferring taxes. Most common in real estate, the exchanges have been done with race horses and airplanes. Warhols and Picassos have been part of the fray since the 1980s.

While legal, 1031s have been under attack by lawmakers. President Barack Obama’s 2016 proposed budget calls for a repeal of tax deferrals on collectibles and new limits in other areas.

“Stefan Edlis has been generous but many people who will take advantage of this will not be generous,” said Robert Storr, dean of the Yale University School of Art.

Storr said the tax deferral on art transactions should be repealed because it protects the rich and feeds a speculative market.

Protecting Wealth

“People at the top of the economic ladder don’t need more mechanisms to protect their wealth,” he said. “I am not interested in making it easier for people to invest in art. It’s ruining the art world.”

Proponents argue that it makes the art market buoyant.

“It benefits not only the tax payers but also a bevy of businesses upstream and downstream,” said Suzanne Goldstein Baker, executive vice president and general counsel of Investment Property Exchange Services Inc. that helps investors swap assets.

“There are a lot of people involved in these transactions: attorneys and accountants, framers, shippers, auction houses, galleries, advisers,” said Goldstein Baker, who is also co-chair of the government affairs committee for the trade group Federation of Exchange Accommodators. “It’s stimulates the economy.”

The capital gains rate for collectibles is 28 percent, compared with as much as 20 percent on securities and real estate.

Tax Hit

“People are more willing to make purchases if they can do it via a 1031 exchange,” said Los Angeles-based attorney Bridgette Toraason. Instead of taking a 28 percent tax hit, “they can spend an extra 28 percent on an artwork. It gives you a whole new buying power.”

To qualify for a 1031 exchange, sellers must show that the art was purchased as an investment instead of for pleasure. Edlis, for example, said he keeps artworks involved in the 1031s in a special storage facility.

“I used to give entire lectures on that: Where do you draw a line between an investor and a collector?” said Ralph Lerner, an adviser who’s done 1031 art exchanges since the 1980s.

Among the rules for an exchange: Sellers must identify works they want to buy within 45 days of the sale and complete the transaction in 180 days.

Edlis said it was “somewhat of a challenge” to find $40 million worth of art that would fit into the collection within 45 days. “The first twenty were easy,” he said.

Third Party

Most exchanges are carried out by a third party, known as a qualified intermediary, which can be an art dealer or a special exchange company that usually charges a flat fee. Investors have to file a Form 8824 with their federal income tax return.

The IRS doesn’t track the exchanges by type, spokesman Anthony Burke said. In 2012, the last year for which information is available, 145 million people filed federal income tax returns; just 194,563 people, or 0.1 percent, filed Form 8824 for all types of like-kind exchanges.

Art exchanges represent a tiny fraction of all exchanges. As a qualified intermediary, Miami-based lawyer Stephen Wayner said he does about 2,000 like-kind exchanges a year; about 20 of those are art-related.

Buy, Sell

Carlos Rivera, a founder of ArtRank, a website that maintains “buy” and “sell” recommendations on emerging artists, said he’s involved in at least one 1031 exchange a month. One client sold a 1980s Frank Stella relief painting and bought 17 works by 11 emerging artists, including Oscar Murillo, Korakrit Arunanondchai, Jamian Juliano-Villani and David Ostrowski.

Another client took advantage of surging prices for Murillo by selling a 2012 painting for $375,000, he said. Instead of paying tax on $345,000 in capital gains, he rolled the proceeds into more art, including works by Franz West and Jonas Wood, Rivera said.

Edlis, the Chicago collector, said he used the proceeds from the sale of “Turquoise Marilyn” to buy more art, including “Figure 4,” a 1959 painting by Jasper Johns, for $17.4 million. In 2009, “Turquoise Marilyn” was included in a loan exhibition of Cohen’s collection at Sotheby’s.

Largest Gift

The Johns painting is one of three by the artist included in Edlis’s donation to the Art Institute of Chicago, the largest gift in the museum’s 136-year history.

Taxpayers donating art to public museums may deduct the gift’s full market value up to 30 percent of their adjusted gross income for six years.

For Edlis, who turns 90 in June, this benefit could result in an annual deduction of $250,000, he said. Selling the works would have made more sense financially, he said, leaving him with $300 million after paying $100 million in capital gains taxes.

He opted for the donation because it was an opportunity to keep the works grouped together and on public view for 50 years, starting in 2016. The museum had attendance of 1.4 million people in 2014.

The museum made “a beautiful proposal,” he said. “Good timing for my 90th.”

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