In estates, the tax rules governing professional artists and their art are both enabling and complex.  On the enabling side of the ledger, art is treated as inventory for tax purposes, which means works can have a NIL value.   Sales, however, are fully taxable as income, not capital gains.  On the complex side of the ledger, among other issues, artists need to take extra care planning estate donations to charity for tax and legacy reasons.

Valuing Art

Canada has financially successful artists who live by selling their works, but most artists – regardless of quality or critical acclaim – have limited sales and significant inventory of works.  The fact that an artist can value their art inventory at NIL for tax purposes is helpful to the full spectrum of artists.  Simply, there are no tax implications for the artists related to their inventory of works until a work is sold or donated.

In 1998, Canada Revenue Agency published a letter on valuing artist inventory at death.  Annually, under subsection 10(6) of the Income Tax Act, the artist needs to elect to value their inventory at NIL for it to be worth NIL at death.  This ensures that transfers to heirs can be at NIL, which is the fair market value (FMV) for the deemed disposition at death.

Transfer to Beneficiaries

At the artist’s death, the inventory is then treated as a Right or Thing per subsection 72(2) of the Act.  If the transfer of inventory to named beneficiaries is within one year of death, the transfer is done at NIL value.  That is, there is no tax paid.  When the beneficiary disposes of an artwork it is taxable as income.

Estate Donation to Charity

Art inventory can be donated at death as an ordinary gift to charity, or, for culturally significant works, as a tax-effective cultural property donation.  I will focus on ordinary donations, especially to artist foundations held by public foundations.

An artist estate can donate inventory at death to a registered charity at NIL value if the transfer occurs within a year of death.  A NIL value transfer means no donation tax receipt is issued.  This can be advantageous, as transferring at appraised FMV will likely be a wash for tax purposes.  The tax liability will likely be equal to or even greater than the donation tax credit.

Executors may also choose to elect the value of the donation for tax purposes under 118.1(7.1).  The election can be any amount greater than the cost (or “advantage” amount) but not greater than the FMV.  The elected amount will also be included in income of the estate, but there needs to be a planning reason to trigger the tax.

Charities are, of course, tax exempt.  Any sale of art inventory by the charity has no tax implication, but the proceeds must be used exclusively for charitable purposes.  Similarly, any grants to other registered charities of art, including public galleries, are tax exempt.

Art inventory in a company

If an artist wants to change the tax treatment of their inventory for donation purposes, she could place art in a company.  Rather than donating art as a gift by will, she could donate shares in the art holding company.  If the art in the company is valued at FMV, the shares in the company would be reflect that value.  An estate donation of the shares would be taxed as capital gains as opposed to income.  The donation would therefore produce greater tax savings for the estate than the associated tax liability.  The excess tax credit could be used to offset other tax liability on the two final lifetime returns and up to five estate returns.

Admittedly, there are not many charities that could facilitate this plan or support artist foundations. The recipient charity would need to be a public foundation or charitable organization with art charitable purposes.  The charity would need experience accepting private company shares and handling art, which would subsequently be transferred from the company to the charity.