Collecting is a hobby that attracts a large number of people. The satisfaction of having a full set of antique stamps or unearthing a rare bottle of wine is easy enough to understand. However, a less easily understood aspect of collecting is how buying and selling collectibles can affect your taxes.
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If you sell a collectible for profit, you may, under certain circumstances, be subject to quite high taxes on that income. It is possible to avoid these more punitive capital gains taxes if you understand the rules that govern when and how they are levied.
What is capital gains tax?
A capital gain (or loss), in simplest terms, is the difference between what you paid for a capital asset and what you are selling it for. A capital asset can be just about anything you own: your house, Netflix stocks, a Van Gogh painting, etc. When you receive a capital gain through the sale of capital property, that money is taxed differently than income you earn from an employer, for example.
If you have held the capital property for more than a year, any capital gains you have received will be subject to long-term capital gains tax. Short-term capital gains or gains from the sale of assets you have held for one year or less are subject to ordinary income tax. Capital gains taxes have a reputation for being lower than the standard tax rate for those who often take advantage of them. This is due to the Taxpayer Relief Act of 1997, which reduced the top tax rate on many capital gains from 28% to 20%. However, this decrease did not and does not apply to collectibles, as the IRS still levies a 28% tax on these specific long-term capital gains.
The one-year period is determined by counting from “the day after the day you acquired the asset to the day you disposed of the asset,” according to the IRS website. This distinction between short-term and long-term capital gains becomes a bit more complicated in situations where you haven’t purchased the capital property that generates the gain. Maybe you inherited a work of art or someone gave it to you. In the event of an inheritance, any capital gain will be considered a long-term capital gain in the eyes of the IRS. If the asset was a gift, the time the donor owned the asset will be included in the timing.
What is a collectible?
According to the IRS, the definition of a collectible is quite open. In Section 408 of the Internal Revenue Code, several examples are given including works of art, carpets, antiques, metals and precious stones, stamps, coins, alcoholic beverages and, most importantly, “any other tangible personal property” that the IRS considers collectible for tax purposes. So there is quite a bit of leeway given to the IRS to decide what is and is not a collectible and therefore what is and is not subject to this 28% maximum tax rate.
How to Calculate Capital Gains Tax on Collectibles
To calculate the amount of tax you owe on a capital gain, you must first calculate what is called your adjusted base. In cases where you purchased the asset, the adjusted basis is the price you paid plus any additional transaction fees *and* any money you spent on restoration or repair. So if you buy a first edition copy of *The Faerie Queene* by Edmund Spenser for $1,200 and also pay a brokerage fee of $90 plus $200 to help preserve it, your base adjusted for the asset would be $1,490.
If, however, you received the asset without purchasing it, such as as a gift or by inheriting it, then your basis will be determined by calculating the fair market value of the collectible. For some collectibles, this can be quite easy to determine, especially if the item or similar items are bought and sold with some regularity. If this is not the case, it may be necessary for an expert to carry out an expertise on the property to arrive at an estimate.
How to Avoid Capital Gains Tax on Collectibles
The surefire way to avoid paying taxes on your collectibles is, of course, not to sell them. Beyond the obvious and possibly silly answers, there are a few strategies that can help lower your tax bill.
First, sell the asset within one year so that the sale is considered a short-term capital gain. Short-term gains are taxed as ordinary income, so if your standard tax rate is lower than 28% (individuals earning less than $170,051 or couples earning less than $340,101 in 2022), then your tax burden would be weaker.
Another approach is, rather than selling the collectible, to donate it to a qualified charity. With this route, you will receive a tax deduction related to charitable donations rather than a capital gain. The exact amount of deduction will vary depending on what the qualifying charity does with your collectible. If the charity plans to use the collectible in its work, your deduction could be as high as the fair market value of the collectible.
Another approach that is not specific to collectibles, but is often used by those who experience a lot of capital gains and losses, is to think about when to “realize” the capital gain. You only owe capital gains taxes when you sell the underlying asset and, importantly, any capital gains taxes you owe in a given year can be reduced by any capital loss you you also suffered. So you can time the sale of a particular collectible so that the taxes on the resulting capital gain are offset by any capital losses you’ve already incurred that year or expect to incur more. late in the year.
The rules surrounding the taxation of collectibles, whether antique violins, rare books, vintage jewelry or the baseball Aaron Judge hit to get his 62nd home run of the season, are complex and in some respects deliberately vague. Difficulties are on both sides of any collectibles deal, buying and selling. However, there are still strategies you can implement to minimize the profits you lose in taxes.
Tax Planning Tips
A financial advisor can guide you through different tax strategies to minimize your liabilities. SmartAsset’s free tool connects you with up to three financial advisors who serve your area, and you can interview your matching advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
If you’re looking for a tax strategy, tax loss harvesting can help you use your investment losses to reduce your capital gains taxes. Here’s how it works.
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