Frank was referred to me following the death of Mary, his wife. Mary was a respected artist and her works often sold for $5k – $10K for an average of $7,500 per piece. Over the years she had build up a personal inventory of works and Frank estimated there were 250+/- pieces when she died. Using the average price her inventory at death would be approaching $2MM+/-.
Mary, like most artists had used a special income tax treatment, subsection 10(6), which treats artists differently from other businesses in how they may value their inventory. Normally inventory is valued based on the costs to produce it (material costs and any direct labour cost, excluding any personal labour). Whereas, artists may elect to value their inventory at $0 and expense all of their material and other direct costs incurred in the year. This means artists don’t pay income taxes on the value of their art inventory, instead they deduct all of the expenses incurred and report as income all pieces sold in the year.
As a result many artists have large inventories of their work which for tax purposes doesn’t have any tax cost. But, the actual market value, depending on the number of pieces and reputation of the artist, may be in the hundreds of thousands of dollars.
When the artist dies the inventory is considered to be a “right or thing” and is to be reported on a Right or thing tax return at nil. This treatment means there are no taxes to be paid on the inventory by the estate. If the inventory is transferred to a beneficiary, they inherit the tax liability. The liability arises as the pieces are sold with the proceeds of each sale being taxable.
However, the nature of the transfer changes what was inventory to the artist to a “capital property” of the beneficiary. As a capital property the sales are considered to be capital gains.
This means only 50% of the sales amount is taxable, whereas the artist would have reported 100% as inventory sales. E.g., art is sold for $10,000, taxable capital $5,000 ($10,000 x 50%). The amount of tax will depend on the beneficiary’s personal tax bracket.
The beneficiary’s estate may have a tax problem if at their death they still hold art with significant fair market value. Being a capital asset, at death there is a “deemed disposition” for income tax. This results in the fair market value of the remaining pieces becoming taxable at death and may create a significant tax bill.
The beneficiary may include a gifts by will provision in their will to have the executor donate some or all of the art work to one or more a registered charities. The executor would then have to get written approval from the charities that they would accept the donation. It would be necessary for pieces donated to be appraised to determine the amount for the donation.
Another option is to arrange to donate to a designated institution or public authority and have the Canadian Cultural Property Export Review Board certify it as cultural property.