Owning and ultimately gifting art and collectibles brings unique challenges to its current owners and potential inheritors. Unlike traditional investments and real estate, the marketability of art and collectibles, whether in the form of fine art, cars, jewelry, wine, furniture, books, or manuscripts, can be erratic and often poses problems when the IRS comes knocking for its share of taxes.
According to reports, over half of owners of collectibles have never had their collection appraised, about two-thirds of collectors have not discussed their collection with a financial advisor, and almost 40% admit to not knowing the current value of their collection.[i]
Case Study
I recently met someone who inherited a sizeable art collection and all the related tax bills and complexities associated with the inheritance. One of the challenges she faced was that some of the art was jointly owned by her and her siblings along with the now deceased mother. While there was an understanding among the family members of who owned what, the documentation they had was lacking, creating some real problems for the estate. Based on my experience and growing knowledge of the estate planning challenges associated with art and collectibles, I thought I would share some insights.
The first thing I recommend everyone do is to catalog and appraise the collections. By doing this, you are ensuring clarity of value for these assets. Do note that not all valuations are the same. Below are three general types of valuations:
- Retail replacement value for insurance purposes
- For instance, a sketch by British street artist Banksy might have an insurance value of $1,500,000. The insurance value is typically the highest appraised value and rarely reflects what an asset might be worth on the open market.
- Fair market value for estate and tax purposes
- The same sketch by Banksy might be worth $900,000 for tax and estate purposes. This is similar to the assessed value of your home for real estate tax purposes – it is typically between 70% and 80% of the Insurance Value of the asset.
- Marketable cash value
- This is the value the sketch would get if sold quickly or used as collateral. In this case the value might be $700,000.
Determining the value of art and collectibles for estate tax purposes can be subjective and complicated. Factors such as the provenance, rarity, condition, and market demand all influence value. Appraisal by qualified professionals familiar with the specific type of art or collectible is crucial to establish a defensible valuation.
Are there any other cases to consider?
In some cases, if certain conditions are met, the IRS allows for a “special use valuation” of qualified family-owned business interests and farms for estate tax purposes. While this typically does not directly apply to art and collectibles, it’s worth exploring whether any analogous provisions could apply to certain types of collectible assets. Separately, partial ownership or ‘fractional interest’ discounts may apply when multiple individuals own shares in a single piece of art or collectible. These discounts recognize that a partial ownership interest may be less valuable than full ownership due to limitations on control and marketability. Proper structuring and documentation are essential to maximize these discounts.
I urge clients to clearly identify and record who owns the art or collectible, where the piece is kept, and how it is used. For example, let’s say you are gifted a $2,000,000 painting by your parents, but it remains in their home. You should clearly record this arrangement; otherwise, there is a risk that the IRS will not recognize the gift and include it in your parents’ estate upon their passing. Moreover, if the painting remains in the parents’ home, a smart strategy (for clarity’s sake) is for you to “pay” your parents a storage fee, or for your parents to pay you a “use” fee. The purpose of this is to be able to clearly demonstrate to the IRS or anyone else who might dispute your ownership that you do in fact own it and have for a while.
What are some strategies that can be implemented?
Now for the fun stuff… Consider gifting some of your collectibles or art during your lifetime. In 2024, US citizens or residents can transfer $13.61 million of assets to heirs or trusts for their benefit free of gift tax. Removing art and collectibles, or any other asset, from your estate can be done in a variety of ways. Once transferred, you can no longer use or benefit from the art, unless the done later agrees to lease the art back to you for a fair market rental fee. Some strategies include gifting the art to a dynasty trust, selling the art to an intentionally defective grantor trust and fractionalizing ownership of the art by holding the art in a limited liability company (LLC) prior to any transfers in order to discount the transfer value and maximize your remaining gift exemption. Structuring ownership of art and collectibles through entities such as trusts, partnerships, or limited liability companies (LLCs) can offer various benefits, including potential estate tax minimization, asset protection, and centralized management. However, the choice of entity and the associated tax implications should be carefully evaluated based on individual circumstances and objectives.
Conclusion
Given the intricacies involved in estate tax matters relating to art and collectibles, consulting with experienced estate planning professionals, including attorneys, financial advisors, and appraisers specializing in these assets, is very important. If you’d like to learn more about how we can help, contact a member of the Wealthspire Advisors team, and we’d be happy to assist you.
[i] Source: The Fine Art Group, citing a UBS published report
