On Oct. 5, the Internal Revenue Service issued a warning (IR-2023-185) to taxpayers regarding promotions for exaggerated art donation deductions that target high-income taxpayers and offered special tips for to avoid getting caught in a scheme. The scheme involves buying art at a “discounted” price and then donating it after a year and claiming a deduction for an inflated fair market value. The IRS warning includes this statement from IRS Commissioner Danny Werfel: “This is another example where people should be careful when it comes to aggressive marketing and promotions. There are legitimate ways to claim an art donation, but taxpayers should be careful to understand the rules and watch out for inflated values or questionable appraisals. Beauty is not always in the eye of the beholder when it comes to tax deductions of art.”
What’s the Scheme?
What should your clients be looking out for? The IRS says that promoters encourage taxpayers to buy various types of art, often at a “discounted” price. This price may also include additional services from the promoter, such as storage, shipping and arranging the appraisal and donation of the art. The promotor promises the art is worth significantly more than the purchase price.
The promoters encourage purchasers to donate the art after waiting at least one year and to claim a tax deduction for an inflated fair market value, which is substantially more than they paid for the artwork.
The IRS has multiple investigations under way regarding these schemes and has conducted over 60 taxpayer audits, which have produced more than $5 million in additional tax. The warning underscores that it’s the taxpayer who will be liable for repayment of taxes owed and penalties.
Red Flags
The IRS warns advisors and taxpayers to look out for these red flags:
- Be wary of buying multiple works by the same artist that have little to no market value outside of what the promoter might be advertising; and
- Beware of appraisals given by appraisers that the promoters recommend to value the artwork. These appraisals often fail to adequately describe the art and may not address the value characteristics, such as rarity, age, quality, condition, stature of the artist, price paid and the quantity purchased.
From the charity’s perspective, it’s a good idea for the charity accepting a donation of art to ask the donor about how they acquired the art and why the charity was the donee, says Christopher Woehrle, an adjunct professor of taxation at the Widger School of Law, Villanova University in Villanova, Penn. If the donor doesn’t have a good answer, that’s another red flag. He adds that donors who donate art soon after its purchased (for example, one year plus a day from purchase) are drawing attention to their lack of philanthropic intent.