Trust & Estate Considerations for Art & Collectible Owners and Inheritors

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:

  1. 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.
  2. 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.
  3. 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. Removing art and collectibles, or any other asset, from your estate can be done in a variety of ways, including gifting into a trust. One such trust worth considering is a Qualified Personal Residence Trust.

A Qualified Personal Residence Trust (QPRT) is typically used to transfer a personal residence or vacation home out of an individual’s taxable estate while retaining the right to use the property for a specified period. If done correctly, the QPRT may include art and collectibles located inside the property.

Here’s how it works:

  1. Creation of the Trust: The property owner (grantor) establishes a QPRT by transferring ownership of their personal residence and its valuable (collectible) contents into the trust. The trust document specifies the terms and conditions under which the property will be managed and distributed.
  2. Retained Right to Use: As part of the QPRT arrangement, the grantor retains the right to use the property for a predetermined term, often referred to as the “retained interest period.” This period can be set according to the grantor’s preferences, typically ranging from 10 to 20 years.
  3. Beneficiaries: At the end of the retained interest period, ownership of the property passes to the designated beneficiaries of the trust, typically the grantor’s children or other family members. By transferring the property to the trust, the grantor effectively removes it from their taxable estate, potentially reducing estate tax liabilities.
  4. Gift Tax Implications: The value of the gift to the trust is determined based on IRS tables that consider the length of the retained interest period and current interest rates. Because the grantor retains the right to use the property for a specified term, the gift is considered a “gift with a retained interest,” and the value of the gift for gift tax purposes is less than the full fair market value of the property.
  5. Tax Benefits: By transferring the property to the QPRT, any future appreciation in the property’s value is removed from the grantor’s taxable estate. Additionally, if the grantor outlives the retained interest period, the property passes to the beneficiaries free of estate tax. However, if the grantor does not survive the retained interest period, the property is included in their taxable estate for estate tax purposes.

While QPRTs offer potential estate tax benefits, there are risks and considerations to be aware of. Some of these risks may include the loss of control over the property once it’s transferred to the trust, the need to pay rent if the grantor wishes to continue using the property after the retained interest period expires, and the possibility of a “claw back” if the grantor passes away during the retained interest period, causing the property to be included in their taxable estate. If the grantor survives the retained interest period, ownership of the property passes to the beneficiaries outright. However, if the grantor passes away before the end of the retained interest period, the property may be included in their taxable estate, potentially negating the estate tax benefits of the QPRT.

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.


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[i] Source: The Fine Art Group, citing a UBS published report
Oliver Pursche

About Oliver Pursche, AAMS®, CEPA

Oliver is an advisor in our Westport, CT office.

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