Collecting is a pastime to which a great many people are drawn. The satisfaction of having a complete set of old stamps or unearthing a rare bottle of wine is quite easy to understand. However, a less easy-to-understand aspect of collecting is how the purchase and sale of collectibles can affect your taxes.
If you need help with tax planning, a financial advisor can guide you in optimizing your financial plan to lower your tax liability.
If you sell a collectible for a profit, you may, under certain circumstances, be subject to some pretty hefty taxes on that income. Avoiding these more punishing capital gains taxes is possible if you understand the rules that govern when and how they’re levied.
What Is Capital Gains Tax?
A capital gain (or loss), put as simply as possible, is the difference between what you paid for a capital asset and what you sell it for. A capital asset can be just about anything you own: your house, Netflix stock, a painting by Van Gogh, etc. When you receive a capital gain via the sale of a capital asset, that money is taxed differently than income you earn from an employer, for instance.
If you owned the capital asset for longer than one year, any capital gain you received will be subject to the long-term capital gains tax. Short-term capital gains, or gains from the sale of assets that you owned for a year or less, are subject to ordinary income tax. Capital gains taxes have something of a reputation for being lower than the standard income tax rate of those who often take advantage of it. This is due to the Taxpayer Relief Act of 1997, which decreased the maximum tax rate of many capital gains from 28% to 20%. However, this decrease didn’t and doesn’t apply to collectibles, as the IRS still levies a 28% tax on these specific long-term capital gains.
The one-year timeline is determined by counting from “the day after the day you acquired the asset up to and including the day you disposed of the asset,” according to the IRS website. This divide between short-term and long-term capital gains gets a bit more complicated in situations where you didn’t purchase the capital asset that’s generating the gain. Perhaps you inherited a piece of art, or someone gifted it to you. In the case of inheritance, any capital gain will be considered a long-term capital gain in the eyes of the IRS. If the asset was a gift, then the time that the gifter owned the asset will be included in the timekeeping.
What Is a Collectible?
According to the IRS, the definition of a collectible is quite open-ended. In section 408 of the Internal Revenue Code, several examples are given, including works of art, rugs, antiques, metals and gems, stamps, coins, alcoholic beverages and crucially, “any other tangible personal property” that the IRS deems a collectible for the purposes of taxation. So there is a fair bit of latitude given to the IRS to decide what is and isn’t a collectible and therefore what is and isn’t subject to that maximum tax rate of 28%.
How to Calculate Capital Gains Tax on Collectibles
To calculate the amount of tax you owe on a capital gain, you’ll need to first calculate what’s called your adjusted basis. In cases where you purchased the asset, the adjusted basis is the price that you paid, plus any additional transactional fees *and* any money you’ve spent on restoration or repair. So if you buy a first edition copy of Edmund Spenser’s *The Faerie Queene* for $1,200, and you also pay a $90 broker fee as well as $200 to help preserve it, your adjusted basis for the asset would be $1,490.
If, however, you received the asset without buying it, say as a gift or by inheriting it, then your basis will be determined instead by calculating the fair market value of the collectible. For certain collectibles, this may be simple enough to determine, especially if the item or items like it are bought and sold with some regularity. If that’s not the case, it may be necessary for an expert to perform an appraisal on the asset to come to an estimate.
How to Avoid Capital Gains Tax on Collectibles
The surefire way to avoid paying any sort of taxes on your collectibles is, of course, to not sell them. Beyond the obvious and perhaps silly answers, there are a few strategies that can help keep your tax bill down.
First, sell the asset within a year so that the sale qualifies as a short-term capital gain. Short-term gains are taxed as ordinary income, so if your standard income tax rate is lower than 28% (individuals making less than $170,051 or couples making less than $340,101 in 2022), then your tax burden would be lower.
One other approach is, rather than selling the collectible, donating it to a qualified charity. With this route, you’ll receive a charitable-giving related tax deduction rather than a capital gain. The exact amount of the deduction will vary depending on what the qualified charity does with your collectible. If the charity plans to use the collectible in their work, your deduction could be as high as the fair market value of the collectible.
Another approach that isn’t specific to collectibles but is often used by those who encounter plenty of capital gains and losses is to be thoughtful about when to “realize” the capital gain. You only owe taxes on a capital gain when you sell the underlying capital asset, and crucially, the capital gains taxes you owe in a given year can be reduced by any capital losses you also encountered. So, you can time the sale of a particular collectible such that the taxes on the resulting capital gain are offset by capital losses you’ve already encountered that year or expect to encounter later in the year.
The rules surrounding the taxation of collectibles, whether those are antique violins, rare books, vintage jewelry or the baseball that Aaron Judge hit to get his 62nd home run of the season, are complex and in some respects deliberately vague. The difficulties are on both sides of any deal on collectibles, buying and selling. However, there are still strategies you can implement to minimize how much profit you lose to taxes.
Tips for Tax Planning
- A financial advisor can walk you through different tax strategies to minimize your liabilities. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re looking for a tax strategy, tax-loss harvesting can help you use your investment losses to lower your taxes on capital gains. Here’s how it works.
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