The New York Times recently reported that Steve Cohen, the billionaire hedgefunder, set to pay what could be the largest SEC fine in history for an insider trading scheme, is selling some important pieces in his art collection. The Times and others speculate that this sale could be because the financier, worth an estimated $9 billion, may need some cash to pay his legal bills. His company, SAC Capital, recently agreed to pay a $616 million fine and he’ll likely be paying over $1 billion when the charges are settled, according to media reports.
But Cohen probably isn’t selling Warhols and Richters from his nearly $1 billion collection because he needs cash. There are better reasons to sell art.
As Shane Ferro at Reuters rightly points out, Cohen sells art all the time. And $60-70 million isn’t going to make a dent in what he’ll likely be paying to the feds.
There’s a less obvious reason why Cohen may sell his art, and it has more to do with U.S. tax law than SEC fines.
Here’s the thing about art: it’s a notoriously bad investment if you may one day need cash. Fine art is taxed at a maximum rate of 28 percent, compared to the 20 percent rate for long-term gains on most investments (before this year, the long-term capital gains rate was only 15 percent). If you plan on selling art in a pinch, you’re sending a lot of money to the federal government.
So, aside from the fact that art is beautiful, why would any investor buy an asset that’s taxed at nearly twice the rate of a stock?
Because art can also effectively minimize taxes. The best return on a massive art collection comes via charitable donations to museums or foundations. But art is also one of the few assets where one can exchange a work for different works to defer taxes.
Here’s how that’s done.
A “1031 Exchange” allows a seller of art to exchange the work for art of “like-kind” and thus, defer taxes that one would ordinarily have to pay when a sale is made. Many buyers and sellers of art use this tax provision to diversify their collections since, in many cases, you can sell a work for $1 million and buy 10 works of “like-kind” for $100,000, sort of like splitting a stock, except you decide when it splits.
K. Eli Akhavan, an attorney at Moses & Singer LLP has an excellent primer on this practice that explains for the American Bar Association here.
It's also sometimes wise to sell art if you have a bad year in the “real” markets because it can potentially offset capital losses. In theory, an investor pays 28 percent on the capital gains once she stops exchanging art. But if she sells works at a gain in a year when she’s incurred capital losses elsewhere in her portfolio, she likely won’t have to pay the maximum 28 percent. (It's important to note that you can’t directly offset long-term capital gains from your art collection for long-term losses in stocks. This is incredibly complicated and the reason why tax attorneys exist.)
But back to Steve Cohen. It’s possible the run on SAC Capital has caused him to liquidate many stock positions at a loss since his investors are fleeing. Art investors usually sell works at a gain when they have other capital losses in their portfolios. So, if you were a billionaire hedgefunder who might soon be required to pay the biggest fine in history, you may just want to make lemonade out of lemons and sell some Warhols in a year that it is likely you won’t be paying the maximum 28 percent rate because of losses elsewhere.
We have no insider information about Cohen’s portfolio or tax situation. But it stands to reason that if he starts selling off massive chunks of his art collection, it may be because it’s a good opportunity to sell high-value art, not because he needs cash.
There’s a broader theme here about the art market: Contemporary art sales happen twice a year, but the sales in November are particularly convenient for the fabulously wealthy people who may use this provision in our tax system to minimize their tax burdens. The end of the year is when wealth managers can accurately assess what they need to do to minimize their clients’ tax burdens. This is also why Q4 is really important for museums and foundations—a good year in the stock market means a great year for philanthropic donations.
Who knows what motivates people to buy and sell anything, but let’s be clear: Cohen is probably not selling art because he’s desperate for cash. It may just be a good year to offload some valuable assets.