Why The Tax Rate For Art Sales Should Be Lowered

"Man will begin to recover the moment he takes art as seriously as physics, chemistry or money" Ernst Levy

What's the best capital gains tax rate for the sale of artwork? There are currently several arguments being made against reducing the capital gains tax rate on the sale of artwork from the current level of 28% to the 15% rate enjoyed by sellers of real estate, securities and other assets. Arguments against the reduction center around the view that art is not an asset which plays any real role in economic activity, particularly job creation, and revenue generation. Nothing could be further from the truth.

When the forces against tax reduction argue that to do so might shift money into art at the expense of more productive activities they fail to appreciate the significant and documented economic impact that art has made and continues to make on everything from job creation, to neighborhood redevelopment to tourism.

Uneven tax policy has also played a role in reducing museum offerings, and hence the public's access to art as a result of the tax treatment of artists. Since they are only allowed to write off the cost of materials for donated works instead of the fair market value of the artwork, artists are less inclined to make donations. The negative impact on museums is compounded by the strength of the art market of late, particularly for Contemporary art, all of which reduces museums' ability to acquire work.

Nevertheless, the value of innovation to our society is becoming more and more clear. Businesses that own and display art are perceived as being more innovative, interesting and desirable places to work. Real estate developers are incorporating art galleries into new condominium towers to entice buyers seeking differentiable living experiences. In connection with its recent renovation, the Aventura Mall in South Florida now includes a twelve-piece, museum-quality art collection designed to be a destination in a clear indication that creativity is valued and valuable.

In the third study conducted by the group Americans for the Arts titled Arts and Economic Prosperity III, data was collected from 116 cities and counties, 35 multi-county regions, and five states. The areas stretched from Walnut Creek, California to Anchorage, Alaska. They found that nationally, the arts generate $166.2 billion in annual economic activity, up 24% over the past five years. That's greater than the 2006 GDP of either Malaysia, Chile, the Czech Republic, Columbia, Singapore, and the list goes on! Furthermore, the arts provide 5.7 million jobs and contribute $104.2 billion to household income,and, they produce $30 billion in annual local, state, and federal revenue.

Two specific examples: In Baltimore City, Maryland, the arts are responsible for $270 million annually, provide 6,500 jobs, and generate $12.6 million in local government revenue. In a study released in June, 2007, Rochester, New York (Monroe County) calculated that the attendance and sales revenues generated by its arts and cultural organizations were responsible for a total $199 million annual infusion into its economy.

Far from playing a neutral role in this country's economy, art continues to demonstrate its uniquely productive role as a strong generator of jobs and tax revenue, just as any other important industry. Therefore there really isn't any defensible rationale for penalizing art investors with an incremental 40% tax bill.

What a Canadian Should Know Before Buying U.S. Real Estate

Many Canadians are dreaming of heading south for the winter, but not just to beat the cold. They have real estate investing on their minds. Our strong dollar combined with a collapsing housing market in the U.S. spells opportunity for many. But Canada and the U.S.A are not the same country, and as much as we have in common we have differences. Any Canadian investor considering putting money in the U.S. should have a basic understanding of some key differences between buying real estate in Canada versus buying real estate in the U.S. So, before you start putting your loonies in Florida or Texas, read on.

Tax Systems:

Talk to an accountant that is experienced with American real estate investment as the countries differ considerably in terms of taxation of investment properties.

In the U.S.

1031 Exchanges allow the capital gains from the sale of an investment property to be deferred and rolled into a purchase of a similar type of property if it's bought within 180 days. This can be done many times allowing capital gains to be deferred until the end asset is finally disposed of and not replaced;


If capital gains are realized (property is sold and cash is received), the seller is taxed at 15% of the total net gain (as long as the property was owned for more than 1 year, if less than, the rate is much higher);


Property taxes tend to be similar to those in Canada, however, if you are a Canadian and own a property in a Southern state like Florida or California, you may have much higher "non-resident" property taxes than either the locals or if you invest in other U.S. States;


Similar to Canadian tax laws, you will not be taxed on your primary residence, however, in the U.S., you can write-off the interest charged on your home.

Compare this to Canada

Sell your investment property in Canada and you'll pay capital gains tax on 50% of the net gain. Canada does not yet have the option of deferring the gain through an exchange. The "gain" or "loss" gets added to your income and your are taxed at the applicable rate (which could be much higher than the standard 15% rate in the U.S.);


Similar to in the U.S., expenses associated with holding an investment property can be written off against your taxable income. See two previous articles for tax time tips: Part 1 and Part 2.

Before you send your loonie south this winter:

Determine if there are "non-resident" property taxes applicable in the city/state you are considering;


If you already own in the States and sell the property (and don't buy another there to use the 1031 Exchange strategy) you'll be required to pay U.S. taxes on the sale. You pay the U.S. first, but still have to file the tax return in Canada (showing the taxes paid in the States). Thus, you'll only pay once (you get a tax credit applied to your Canada taxes), but you have to file 2 returns (February/March 2008 Money Sense has a great article on this issue);


Rental income requires two filings for taxes as well. You must claim the income (and expenses) in both countries, pay the applicable taxes, and get a credit for your Canadian taxes.

Lending differences between Canada and the U.S.:

The "credit crunch" or "subprime market meltdown" has had a dramatic impact on the U.S. lending environment, and has trickled over the border to Canada. Because of the economic crisis, lender guidelines and policies have changed dramatically in both countries. In the U.S., there were many mortgages given to just about any candidate. The phrase "ninja" loan was coined in the U.S. The acronym standing for "no income, no job, no assets". Many individuals were given mortgages beyond their means. When the first large phase of ARM (adjustable rate mortgages) began to raise their rates, foreclosures began popping up all across the nation. Canadians need not fear the same crash here thanks to very different lending environments.

In the U.S.

Hundreds of banks across the country with hundreds of differences in lending policies and guidelines;


Licensing varies across each state for who can be a mortgage broker. In some states no testing or licensing is required at all!


Bank regulation is controlled at the state and federal level, again possibly leading to less strict lending criteria from one bank or lender to another.

And in Canada

One federally-regulated Bank Act that controls what banks can and cannot do across Canada;


Only 5 major banks in Canada that control a large majority of all banking divisions;


All of the Big 5 Banks in Canada are able to lend funds for mortgages, but they have also acquired (and oversee) many of the licensed trust and brokerage companies (which lend money as well);


Mortgage brokers are provincially regulated in Canada, but the majority of provinces require extensive training, and the successful completion of a licensing test.

Economic Conditions in Canada and the U.S.:

The Canadian economy continues to enjoy good economic times with historically low unemployment rates, increased wages, and housing appreciation. At the same time, a recession has been lurking in the U.S. Many areas of the U.S. are experiencing depreciating houses, high unemployment rates, and deteriorating consumer confidence.

There could be some real bargains to be found in the U.S. as foreclosures pile up, property/houses depreciate (well into double digits in some States - Florida, Michigan, California), and our Canadian dollar continues to sit around par with the greenback. But before you take the plunge, do your research. Most economists still believe we are in the midst of the subprime fiasco. They forecast continued depreciation across the nation (obviously much worse in some areas than others) for the better part of two years. So, unless you really know an area is going to get better soon, I personally, would wait and see what the summer and early 2009 has to bring. The election, the war, federal policies to "bail-out" millions of credit-burdened borrowers, and the worst part of the subprime scenario which is predicted to hit in the fall of 2008, are all factors that will impact investment in the coming year, and it's a gamble to buy without knowing what will happen. But, with the strong dollar, it's a good time to head south and start looking for that dream home in Florida, isn't it?

Some final thoughts (in this article anyways) on investing in the U.S. real estate market. If you are intent on purchasing in the U.S. and are a Canadian citizen residing in Canada, the following three ways may help you obtain financing:

Take out a mortgage in the U.S. through a U.S. based bank owned by a Canadian one such as RBC Centura or Bank of Montreal's Harris Bank;


Purchase using all cash so you don't have to deal with cross border financing issues (e.g., pull equity out of your home or other Canadian properties or ask your rich aunt for money!) to buy down south; and


Create a corporation in the U.S. with assets (a holding company will not work as it needs to have equity or be generating revenue) which can obtain the mortgage from a U.S. lender.

Australian Taxation - How Long Should Business Records Be Retained?

A case that was recently decided in the Federal Court highlights a problem in relation to the keeping of business records. During the 1988 income year, a unit trust engaged in the purchase of a significant investment. It was not a good investment. Not too long afterwards the investment was worthless and in May 1993 the investment was sold for $1. This resulted in the unit trust incurring a capital loss of nearly $2.5m.

All of the units in the trust were sold from the original owner to a new owner in two tranches. One was in June 1993 and the other was in June 1995.

Capital losses may only be deducted for tax purposes against capital gains. Put another way, capital losses may not be used as a deduction against normal income. Due to this, the capital losses were carried forward by the unit trust until a capital gain was made by the unit trust in 2001.

The Australia Taxation Office ("ATO") raised amended assessments against the ultimate beneficiaries of the trust and would not allow the capital loss of $2.5m to be set off against the capital gain made in 2001. The beneficiaries objected to this and the matter found its way to the Federal Court.

The main argument of the ATO was that the trust had fundamentally changed through some things that happened in 1993. I won't go into the details of that.

However, the ATO also argued that the taxpayers could not prove that the purchase of the investment occurred in 1988 because, among other things, the primary documents that evidence the transaction no longer existed. This was so even though the financial statements of the unit trust showed the acquisition and there was verbal evidence from the people who actually engaged in the transaction. I note that the financial statements were prepared by a reputable firm of Chartered Accountants.

In his testimony before the court, the original owner of the units said that he did not have any of the business records of any of his companies or entities from 21 years ago. I know of few people that would.

So here's the point. Generally, businesses are required to keep their records for a five year period under the Australian taxation law. But when it comes to capital gains tax, you need to keep records of everything that may be relevant to working out whether you have made a capital gain or capital loss. And, according to the ATO publication "Record Keeping For Small Business", "You must keep these records for five years after you sell or otherwise dispose of an asset...". So, you may need to keep the records for a very long time.

You will note in the case I refer to above that the ATO required the taxpayer to produce business records of a transaction that was 21 years old. Further, the disposal of the investment occurred in 1993, so that was 16 years earlier (not five).

The moral of the story is this: if you think that a transaction may have long term significant tax implications, don't (ever?) throw out the primary documents that relate to that transaction. Keeping an electronic (scanned) image is something that you should consider.

Wishing you easier business.

John M. Jeffreys

Down Size With Reverse Mortgage, Move Your Tax Base & Take A Capital Gains Exemption? It's Possible

A future trend for Southern California Boomers? For Boomers and Seniors living in other areas, two out of three isn't bad either.

The house is big, the kids are gone, you're tired of maintaining the yard and you and your spouse only use half of the house. Could it be time to move and at the same time increase your retirement nest egg and cash flow?

The passing of HR. 3221 and the modernization of FHA and reverse mortgages is a step in the right direction in helping boomers and seniors plan for their retirement. The improvement is yet to be measured but here are some interesting thoughts.

Within the last couple of weeks the president signed into law HR 3221. Amongst many things, this law will do is dramatically change reverse mortgages. It will:

o Increase the loan limits for reverse mortgages (limits have yet to be defined publicly by HUD) - which means more liquid cash for reverse mortgage recipients.
o Capped origination fees - 2% of the first $200k of the maximum claim amount, plus 1% of the balance above $200k to a maximum origination fee of $6000. On average this will reduce origination fees by over $1200 for Southern California reverse mortgage borrowers.
o Enable to use the FHA HECM reverse mortgage for HOME PURCHASE
o Enable the FHA HECM reverse mortgage to used on co-ops, amongst other improvements

In 1986, California voted to provide tax relief (Proposition 60) to homeowners older than 55 by allowing (with some restrictions) to transfer their existing property tax base to replacement homes of the same or a lesser value within the same county or a participating reciprocal county (Proposition 90). As the boomers begin to retire and look to trade into smaller, age friendly single story homes, or consider 55+ communities, using this proposition may become more popular. You can use this benefit one time. There are numerous restrictions including a single person or spouse must be 55 years old when selling your original property. Your new property must be a principal residence with the current market value equal or less than your original residence. Proposition 60 covers property transfers within the same county. Proposition 90 allows property tax base transfers with participating counties of Alameda, Los Angeles, Orange, Santa Clara, San Diego, San Mateo and Ventura counties. Be sure to contact your tax assessor's office for current information.

Taxpayer Relief Act of 1997 changed the way real estate capital gains taxes are calculated. The IRS issued updates in 2003. This rule offers up to $250,000 tax free sales home profits for a single person and up to $500,000 profits for a couple. To qualify the seller must have owned and occupied their principal residence a total of two of the five years before the home sale. (Consult your tax expert for updated advice)

Even with today's softened housing market, many home owners have substantial equity in their homes. There is an opportunity to take advantage of these gains and improve your retirement plan with multible opportunities.

Here is an example:
Mr. & Mrs. Jones both age 70, sell their current home for 1 million in Los Angeles County; Original cost of home: $250,000; Mr. & Mrs. Jones decide to buy a home for $500,000 in Ventura County. Gain on the sale: $500,000; Exclusion for couple filing jointly: $500,000; Taxable gain: $0. Mr. and Mrs. Jones transfer their original property tax base with them, keeping their original property tax base. They take their $500,000 exemption and buy their home in Ventura County with a FHA HECM reverse mortgage. The FHA HECM reverse mortgage allows them to either pay $300,000-$320,000 for their $500,000 home, they have no mortgage payment and they pocket the difference tax free. Mr. and Mrs. Jones may also purchase their new $500,000 home with a reverse mortgage and further increase their monthly cash flow by $6-700 a month buy opting for the tenure payment option for life.

All three of these opportunities will soon be available to many Southern California retirees. The capital gains exemption is available to everyone. As soon as HUD issues the green light, FHA reverse mortgages will be available for use in home purchases for borrowers 62+ years old, throughout the USA.

The Boomer generation turned 62 this year. With the increasing popularity and practical application of reverse mortgages into the main stream, it is not unreasonable to expect to see the incorporation of these and other cash flow tools in retirement planning on an increasing basis.