Art and Collectibles: The Missing Piece of the Estate Planning Puzzle

Robin Kalota of Plan Art, LLC informs professionals about the importance of considering art assets in the estate planning discussion with clients.  As art holdings continue to grow advisors, should take special consideration in the estate and tax planning process.

Robin Kalota

It’s time for the client annual estate planning review.  You pull out the Client Trust Information Update Questionnaire, and after you update the name, address, marital history and status of children you move on to the meat of the questionnaire. The Assets:  Residence, cash, business interests, real estate holdings, stock investments, life insurance, retirement plans, automobiles, boats, furniture, and household goods.  Then you move on to the will and trust provisions including the beneficiaries of the Estate. And, oh yes, the Other Assets.

What’s behind the motivation to collect?  In their survey of high net worth buyers for the report, Art Basel UBS found that the most highly ranked

What’s behind the motivation to collect? In their survey of high net worth buyers for the report, Art Basel UBS found that the most highly ranked

ALotOfPeople via iStock

Like Art and Collectibles? You mean assets like paintings, prints, sculpture, watercolors, classic cars, antiques, coins, stamps, sports memorabilia, historical memorabilia, carpets, silver or books, rare manuscripts, all of which are included in the IRS definition of arts and collectibles, Reg. §20.2031-6(b).[1]

Global art sales reached nearly $67.4 billion in 2018, according to the Art Basel UBS 2019 Art Market report,[2] which includes both the auction market and dealer sales. The appetite for art continues to be strong and growing. The three largest markets, in terms of sales and accounting for 84% of global market value, are the United States, United Kingdom and China.  Of those, the United States was the largest market worldwide, driving growth with 44% of total sales by value, or $29.9 billion in 2018.

The Motivation Behind Collecting

What’s behind the motivation to collect?  In their survey of high net worth buyers for the report, Art Basel UBS found that the most highly ranked factors worldwide were for aesthetic and decorative considerations, with 87% of the aggregate sample ranking those reasons as highly important. Those driven by art collecting as a passion or expression of their personalities represented 86% of the aggregate sample. Not far behind - expected return on investment, portfolio diversification and social reasons all weighed in as being important to more than 70% of the aggregate sample.[3]

The Artnet 2019 Art Intelligence Report adds another perspective. As the number of wealthy individuals around the world grew from the late ‘90s into the 2000s, demand for artworks as symbols of refinement and success drastically increased—and contemporary art offers inherent advantages over older art among all but the most moneyed.  Indeed, postwar and contemporary art sales accounted for half of the fine art auction market’s value in 2018.[4]  While the very top of the market became increasingly sophisticated about which pieces across different genres were worth significant price premiums, the majority of high net worth gravitated to the next best and most available thing. And works by living (or recently dead) artists vastly outnumbered the classics.[5]

And the marketplace is broadening and expanding thanks to the proliferation of global art fairs and online venues. Despite the headline news around the sale of trophy and celebrity art, the market for reasonably priced and accessible art makes it an asset class to be reckoned with when it comes time for planning.

The Need for Art-related Services Spans Generations

According to the 2017 Deloitte ArtTactic Global Art & Finance report, 64% of wealth managers surveyed for the report said they were actively offering services related to art and collectibles, with 55% of managers saying that an increasing number of clients were asking for help with art-related issues.[6]  The most important art and wealth management service being asked for…estate planning. That is not surprising given that buyers between the ages of 40 and 65 are a key demographic for both dealers and auction houses.

Add to that the growing spending power of millennials. Millennial collectors were the most likely overall generation   to have purchased fine art (69% across all countries), with a higher-than-average share in all countries.[7] On aggregate, differences in wealth levels did not have a pronounced effect on purchasing in the main art segments, apart from a tendency of those at higher levels to purchase antiques. According to the Art Basel UBS report, the millennial generation had considerably more active buyers than others in all segments, with a majority having been active in the fine art, decorative art and antiques markets, spending $1 million or more on all categories of art over the last two years. [8]

The need for art planning spans across all generations, whether it’s for next generation gifting or simply the transfer of art to make room for new additions. And with a massive transfer of wealth expected from baby boomers to millennials, art and estate planning are likely to become increasingly important.  While the conversation around planning is, and has been, happening at the high value end of the market, the need for planning is not just for the ultra-high net worth anymore.  In fact, the increasing value of art-related wealth and the concomitant desire to safeguard the financial as well as the social and emotional value of that art, has led to an increasing awareness among collectors of the importance of planning.

Art’s Role in Diversifying Portfolios

As expected, sales in the art market are closely linked to the global economy, with income, consumption and investment all key variables. As other asset market returns diminish, market participants increasingly look to use art to diversify portfolios much like investing in other tangible assets, such as real estate or precious metals, especially in this era of declining interest rates. 

Why Art Succession Planning Matters

Beyond the obvious reasons why estate planning matters, art succession planning goes one step further. How so?

  • It empowers the collector to take an active role in the estate planning process.
  • Addresses the artistic and financial value of the collection.
  • Planning protects the family from disputes over the division of art assets once appraisal values are obtained.
  • Planning protects the beneficiaries’ step-up basis.
  • Planning ensures the artistic vision of the collector survives over time and family.

It all depends upon the objectives of the collector, and what is driving his/her decision.  Does the collector want to share the passion for art, either by gifting or donating, or share the wealth by monetizing art or tax planning.

ASK! Identify the Tangible Assets

The first step in this discovery process is confirming the existence of the client’s art work or collectible, whether it is   just one or a few items or an entire collection.  Ask! Determine whether the client has even spoken with family members about the ultimate distribution of their art and collectible assets. As set forth in the Deloitte ArtTactic report, almost half of collectors surveyed haven’t yet discussed their art related estate plans with their heirs.[9] How much does the family even know about the art collection. Is there an updated Fair Market Value (FMV) appraisal to determine educated decisions? Do heirs share the same passion as the collector? Do they want the art, or just the dollars that come from selling the art? How important is it to set the FMV date of death so the heir will obtain the step up basis?

Knowing the Collection = Knowing the Fair Market Value

Knowing about the art collection requires knowing the actual fair market value of the art assets.  According to the IRS’s definition, the fair market value for art and collectibles in estates is the price at which the property could change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell.  The fair market value of a particular item of property includable in a decedent’s gross estate is not to be determined by a forced sale price, nor should it be determined by the sale price of the item in a market other than that in which it is commonly sold to the public. Reg. §20.2031-1(b).

Getting a handle on the extent of the collection and its value, and then understanding the family motivations around the art assets is a critical starting point for the advisor. Failing to identify the client’s tangible wealth and failing to determine their intentions can lead to an inequitable distribution of estate assets, plus lead to family disputes around the division of valued pieces.  It is also a must when choosing among the planning options for art.

Is the Collector informed about the Collection?

Indeed, don’t assume that the collector really knows his or her own collection beyond the name of the artist and title. A short list of questions that need answering might include:

  • Does the collector have an updated inventory of the collectible holdings, including such details as medium, dimensions, signature, date of creation, cost and more;
  • Can the collector identify the high value art versus art assets that have more emotional than monetary value;
  • Has the collector obtained a FMV appraisal within 3 years?
  • Has he/she kept all her records, receipts, bills of sale, past appraisals, insurance reports and evidence of ownership.

The answers to these questions are also key to identifying which items will need to be appraised.

That knowledge will make the difference in determining whether to advise a client to sell, incurring both tax and transaction costs, to gift to family members, often through more sophisticated structures like LLCs or trusts, or to leave a legacy by donating to a charitable organization.

Clearly, not every piece of art or collectible merits a high level of scrutiny or meets the need to be appraised. But appraisals are required for any taxable transfer, i.e. any work of art or collectable that will be donated, gifted or goes through the estate administrative process, and that meets  certain artistic or intrinsic value requirements. Internal Revenue Bulletin 2006-46 has provided notice of the increased competency requirement for appraisers in charitable contributions; this elevated criteria is also expected to eventually cross over into estate and gift tax appraisals.

Who is a Qualified Appraiser?

A qualified appraiser is an appraiser who has either earned an appraisal designation from a recognized professional organization or has met minimum education and experience requirements.  They must also regularly perform appraisals for which they receive compensation and have demonstrable verified education and experience in valuing the type of property being appraised. In choosing the appraiser, the advisor should inquire as to whether the appraiser is familiar with the market, and whether she has dealt with the subject matter being appraised.[10]

For both charitable contributions and estate appraisals, the appraiser must have no conflict of interest. Excluded individuals include a donor, donee, or a party to the transaction in which the donor acquired the property, is employed by, or related to, any of the foregoing persons, or married to any person who is related to any of the foregoing persons.

If the appraiser is regularly used by the donor, donee, or party to the transaction, the appraiser must also have performed a majority of appraisals for other persons.

In all cases, a “Disinterested Appraiser” must be used. Of major concern is evidence of bias or conflict of interest.  An appraiser cannot appraise works of art and collectibles and then sell, or have sold, the same items.[11]

When is an Appraisal Required?

For estates, under Reg 20-2031-6(b); IRS form 706, Schedule F, an appraisal report is required for art and collectibles worth $3,000+ each, or $10,000+ for an aggregate collection. An executor certification is also required. That is a written statement by the executor under penalty of perjury as to the completeness of the itemized list of such property, and as to the disinterested character and qualifications of the appraiser. The Executor certification must be attached to the appraisal.

For charitable contributions, under Code Section 170(f)(11)(C), form 8283, an appraisal report is required for art assets over $5,000. If the item or collection of similar items is over $20,000, then it must be attached to the tax return.

All returns involving any form of artwork, collectibles or cultural property with a claimed value over $50,000 must be referred to Art Appraisal Services (AAS) for possible review by the Art Advisory Panel, which reviews and adjusts art appraisals submitted to the Internal Revenue Service (IRM 4.48.2 and IRM 8.18.1.3)

What are the odds for adjustment by the AAS? In 2017, of 94 items submitted for charitable contributions, values were reduced on average by 26%; of 128 items submitted for estate and gifts, values were increased on average by 35%.  The average claimed value per item in 2017 was $562,831.[12]

Using an appraiser with a designation from a recognized appraisal organization goes a long way to establishing that the collector and his/her advisor tried to hire a qualified and competent appraiser, and that the appraisal is consistent with the substance and principles of the Uniform Standards of Professional Appraisal Practices (USPAP).

For the planning attorney who wants to minimize exposure to valuation issues, an IRS Statement of Value can be obtained for any one item that has a value of at least $50,000 and meets specific substantiation requirements.  An advance ruling works much like insurance – it establishes an art valuation that the advisor can rely on, and can be used for income, estate and gift returns. (Revenue Procedure 96-15; 2018-01).

To Schedule or not To Schedule

Another issue that often arises is the question as to whether to schedule or itemize the art in an estate. Clearly the more valuable the collection the greater the need for scheduling.  After the passing of the collector, the spouse, child or advisor is then liable for proper reporting of assets. As noted earlier, the executor will be held liable if an item is missing that should have been included.  Intentional misrepresentation by omission is considered fraud…. And fraud is forever.

Equally onerous is if an estate underreports the value of an artwork for estate tax purposes and faces rejection, and perhaps penalty, by the US Tax Court.

A potentially negative consequence of not scheduling falls on the shoulders of the heirs. If there is no appraisal, there is no established value, and there is no possibility of a stepped-up basis for the heirs when the property is transferred after the death of the collector.

Even with the 2019 estate and gift tax exemption amount at $11.4 million per individual, the family still needs to make decisions around lifetime gifting versus income tax basis planning.  With a relatively high capital gains tax of 28% on all art and collectibles, and the fact that the recipient of the gift inherits the cost basis of any gifted assets, the decision to gift versus sell becomes more relevant to overall planning decisions.  Transfer tax savings that could be achieved by a lifetime gift must be compared with potential capital gains taxes that might be due.  In fact, even in situations where there are no transfer taxes due, when considered in light of other planning actions, it might be preferable for the art to be held until the collector passes, and the basis can be stepped up to fair market value.  Art investors and advisors need to be even more strategic when the prospect of passing along a high capital gains tax bill trumps the benefit of gifting for both parties.

Putting the Estate Planning pieces together

An art collection is increasingly a critical piece of the overall estate planning puzzle, but one that is often ignored or given short shrift. That means tremendous value could be left on the table when the overall estate plan is devised. Incumbent on both the advisor and the collector is to build a team that includes art advisors, appraisers, and curators  who can help open the lines of communication and  address the fate of the less obvious assets hanging on the wall.   

Endnotes

1.     IRS Reg. 20.2031-6(b) Section 4 Definitions

2.     Art Base/UBS; The Art Market 2019, prepared by Dr. Clare McAndrew, pgs 28-29, Summary

3.     Art Basel/UBS, The Art Market, pg 357, Figure 7.20; Motivations for purchasing art.

4.     Art Basel/UBS, The Art Market 2019; Auction Sales, Pgs174-175

5.     Artnet 2019 Intelligence Report; Welcome to the Age of the Art Industry; pgs 29-30

6.     Deloitte  ArtTactic Global Art & Finance Report, 2017;  Section 2. Art & Wealth Management Survey. Pg 98-99.

7.     Art Basel/UBS, The Art Market 2019, Global Wealth and the Art Buyers; Pgs 348-349

8.     Art Basel/UBS, The Art Market 2019, Global Wealth and the Art Buyers; Pgs 348-349

9.     Deloitte ArtTactic Global Art & Finance Report 2017; Section 2, Art and Wealth Management Survey; Pgs 100-101.

10. Art Law; Ralph E. Lerner & Judith Bresler; 4th Edition; Tax & Estate Planning for Collectors; Pg 1238

11. Reg.§20-2031-6(b); See Joy Berus, The Art of the Valuation of Art, Antiques and Collectibles in an Estate, December 2008, Journal of Practical Estate Planning

12. Annual Summary Report for 2017; The Art Advisory Panel of the Commissioner of the Internal Revenue.

Robin Kalota
Founder, Plan Art LLC
12 Lyra
Irvine, CA  92603

Robin@planartllc.com
www.planartllc.com
562-237-2000

Robin Kalota is the founder of Plan Art LLC.  Her practice focuses on helping families determine planning options for their art assets.  This includes art collection analysis, procuring the appropriate appraisals, valuation of the collection and identifying transfer options such as donation, selling or gifting art, and evaluating how, when and to whom the collection will be transferred.

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Robin Kalota

Founder of Plan Art LLC.  Her practice focuses on helping families determine planning options for their art assets.  This includes art collection analysis, procuring the appropriate appraisals, valuation of the collection and identifying transfer options such as donation, selling or gifting art, and evaluating how, when and to whom the collection will be transferred.