Art: for love or money?

With uncertainty in the current economic climate, investors are looking to alternative options for investments. Art is one example of an ‘investment of passion’ that can be used to structure tax affairs.

The first matter for an investor to consider is how long they intend to own the artwork. To see any sort of increase in value, a piece of art usually has to be held for about five years before a sale is considered. A sale will bring about a charge to capital gains tax (CGT) if there has been an increase in value.

There is an exemption of £6,000 for the sale of any personal effect, so if the proceeds of sale do not exceed that amount it does not have to be entered into the annual self-assessment tax return or declared to HMRC.

If the proceeds of sale are more than £6,000 but less than £15,000 then either the lower of the actual gain or the maximum chargeable gain is declared. For example, if a painting was sold for £8,000 and was originally bought for £1,000 with sale costs of £500, the actual gain would be £6,500.

To calculate the maximum chargeable gain, calculate the amount by which the proceeds of sale exceed £6,000 and multiply this by five-thirds, which in this example comes to £3,333.33; as this is the lower figure, it is declared in the tax return.

If the proceeds of sale are more than £15,000 then the actual gain is declared. The rate of CGT is either 18 per cent or 28 per cent, depending on the amount of other income the investor receives.

Special rules apply to sets of chattels, such as matching ornaments, vases or statuettes, to name a few examples. The limits usually apply to the whole set so it is not possible to sell each one separately to claim the exemption for each piece.

If, of course, an unwise investment has been made and the piece of art suffers a downturn in value since purchase, any loss on a sale can be offset against any other gains made in the tax year on other assets. So, not all is lost on such a purchase.

Tax matters

An investor may think they will buy future family heirlooms and gift them or pass them down to the next generation on death. However, these have tax implications to consider.

Any lifetime gift of a piece of art may give rise to a charge of CGT, which would be calculated on the same basis as mentioned. Survival of the gift by seven years is vital to ensure that the value falls out of the investor’s estate for inheritance tax (IHT) purposes. One advantage of gifting is that the piece of art would be valued at the date of the gift, rather than at the date of death, so even if the investor does not survive seven years, there may be a tax saving to be made.

Gifting art

But what if you want to gift your prized piece of fine art that hangs over the fireplace and still give it away to the next generation for IHT planning purposes? The only way to avoid the gift with reservation of benefit rules would be to make the gift, retain possession and pay a commercial rent for enjoying the work of art.

How is rental value calculated? A market valuation of the artwork would be carried out by a professional and the rent would be somewhere in the region of ?1 per cent of the market value per annum.

Again, surviving the gift by seven years is required to ensure the value falls out of the estate for IHT purposes, but the rate of rent is a lot less than the rate of IHT at 40 per cent that could potentially be payable. The disadvantage is that the person receiving the rental income has to declare the income on their tax return and pay income tax at their applicable rate.

Any pieces of artwork owned by someone on their death would be subject to IHT as an asset of the estate. The market value of household and personal effects are declared on form IHT407 as part of the IHT account.

Generally, any personal effects with a value over £500 are listed separately and individual values given. Section 160 of the Inheritance Tax Act 1984 defines market value as: “The value at any time of any property shall, for the purposes of this Act, be the price which the property might reasonably be expected to fetch if sold in the open market at that time.”

Executors of an estate have to take great care when declaring the value of any personal effects, including art collections. Professional valuations should be sought and submitted to the Revenue with the IHT account; if none accompany the account, the Revenue will almost certainly ask further questions.

The shares and assets valuation team at the Revenue monitor the sale of items at auction houses to check that the values given are accurate. As penalties may be charged for incorrect submissions, the cost of a professional valuation is a small price to pay.

One exemption that is worth any art investor exploring is the conditional one. Any pieces that are of national interest or importance can be referred to the heritage department of the Revenue and, potentially, IHT on the value can be deferred.

Usually, the owner has to undertake to preserve the asset, allow reasonable access to the public and keep it in the UK. As soon as the undertaking is broken or the asset is sold or given away, the tax becomes payable.

Insurance premium

So, before investing in fine art what other considerations have to be made? The first is the cost and arrangement of insurance for these valuable assets. Small collections can usually be covered by the household contents insurance, but any art of great value should be insured by a specialist company. Insurance premiums are likely to be significant, so this ongoing cost has to be factored in when making the purchase.

Another problem for the art investor is that to maintain their value, works of art have to be kept in immaculate condition and one way of doing this is to place them in storage. The prudent investor then has to consider the risks of damage while in storage and the added cost of the storage itself, plus the fact that it cannot be enjoyed as if it was displayed at home.

Apart from a possible increase in insurance premiums and a risk that any art not stored safely may decrease in value, there are some tax savings to be made in terms of CGT and IHT. This involves careful planning, and professional advice should always be sought.

Bottom line

Investing in art, whether a serious collector or not, requires careful thought and will not necessarily provide big returns. It is also important to remember that unlike equities, bonds or property, art does not produce an income.

It therefore remains an unpredictable investment, and can be subject to changes in trends and fashion, although equally it has shown positive returns over the long term (outperforming equities over the last ten years).

China is now the largest worldwide art and antiques market having overtaken the US market for the first time in 2011. In fact, many Chinese people are reacquiring pieces that were ‘removed’ from China in colonial times.

You cannot, of course, guarantee that when you want to sell you will find a ready buyer for your art, however, and as a large proportion of art is traded privately, it can be difficult to measure how well it does perform as an investment.

But purchasing artwork as part ?of an overall portfolio of investments may be a good choice in these times where the returns from other investments are uncertain. Overall, the message from many art experts is to buy something you are passionate about, rather than look at it purely for its investment potential.