July 01, 2017

Practical Planning for Art Collectors and Their Advisors, Part 2: Disposition

Ramsay H. Slugg

This article suggests that lenders’ lawyers should consider expanding the degree to which they review title, to a level beyond what is the current custom in many jurisdictions, and highlights common problems that can be easily uncovered by such a review.

Download PDF ArticleThis is the second of a two-part article based on the author’s book, Handbook of Practical Planning for Art Collectors and Their Advisors. Part 1, “The Ancillaries,” Prob. & Prop., Mar./Apr. 2016, at 6, focused on those matters the collector should take into consideration regardless of the ultimate disposition of the collection; Part 2 focuses on planning for that ultimate disposition.

Collectors often are overwhelmed by a seemingly endless number of choices of what to do with their art, but they really have only three choices: sell it, transfer it to family members (or other noncharitable beneficiaries), or donate it to a charitable beneficiary. And there are only two times collectors can do something with their art: when they are alive, and when they are not.

Three times two equals six . . . and this is the number of options collectors have. These options are not mutually exclusive, and, in fact, it is common for a collector to use more than one. But these options are exhaustive. There are no others, unless, of course, the collector selects the default option, which is to do nothing. Doing nothing may be the right choice, unlikely though it may be. But even if doing nothing is the right choice, it should be an educated one.

One non-option to avoid is the “empty hook” option, which supposes that the family will remove the art from the collector’s home and not report it on the federal estate tax return or otherwise as a taxable transfer. This approach is illegal. Furthermore, if a Form 706 is required, it will provide hints to an examiner about whether an appropriate amount of tangible personal property is reported. An examiner also routinely will request insurance policies, which may reflect the ownership of art. Finally, it is unethical for advisors to participate in this type of approach.

Setting aside the do-nothing option, this article will explore the six real options available to a collector:

  • sell during life;
  • make a gift to family or other noncharitable beneficiaries during life;
  • donate to charity during life;
  • sell at death;
  • bequeath to family or other noncharitable beneficiaries at death; and
  • donate to charity at death.

The Big Question

We do need to get the hardest question out of the way first, and that is, “Does your family want your art?” This does not mean the value of the art, but the art itself. The answer to this question will lead to which of the planning options is appropriate.

The term “family” should be considered collectively and broadly. It could be that some family members love the art as much as the collector does, while others do not. It is similar to a family business in which some of the next generation will be involved and others will not be involved. Most people want some sort of equality of distribution, and this desire most often can be dealt with by using other assets or life insurance.

So the question is, “Does the family care about the art?” If not, then this answer likely will lead to a sale or donation to charity. If the family does love the art, then this answer likely will call for a wealth-transfer solution, either during life or at death.

Selling—During Life

Selling the collection—in whole or in part—may be the right choice, but the collector should be aware that art is perhaps not only the most expensive asset that he will ever buy, but it also likely will be the most expensive asset that he will ever sell.

To understand the income tax treatment for sales of art, it is first necessary to determine into which taxpayer category the collector falls—collectors, investors, or dealers.

For collectors and investors, art is a capital asset. If it has been owned for a year or less, then any gain on sale will be subject to federal income tax at ordinary income tax rates. If the art has been held for over one year, it is a long-term capital asset.

Art is a collectible, as defined in IRC § 408(m). The federal long-term capital gains tax rate for gain realized on a sale of collectibles is as high as 28%.

Also, for collectors and investors, the health-care surtax of 3.8% applies to net investment income above certain amounts, so that the top federal income tax rate on gain realized from the sale of art is 31.8%.

High income taxes do not mean that selling is not the right option. It simply means that the collector who sells during life will incur significant expenses in doing so.

Movin’ On Up

For investors, but not for collectors or dealers, it is possible to “trade up” by entering into a “like-kind” exchange. Federal capital gains tax (and, because of the way it is calculated, the 3.8% surtax) can be deferred under IRC § 1031 if all requirements are met. State income tax laws addressing like-kind exchanges vary, so state law should be checked to determine if state tax deferral of a like-kind exchange applies.

Gain is deferred by assigning the cost basis of the piece of art that is sold to the newly acquired piece. This is not gain avoidance but gain deferral (unless held until death, at which time cost basis is “stepped up” to its fair market value, and gain is permanently avoided).

Section 1031 exchanges have four requirements:

  1. there must be an exchange;
  2. the property exchanged must be of a kind that qualifies—art and other tangible personal property generally do;
  3. the property received in the exchange (the “replacement property”) must be of a “like kind” to the property relinquished; and
  4. both the relinquished property and the replacement property must be held for productive use in a trade or business or for investment.

Collectors generally are viewed as being engaged in a hobby, not engaged in a trade or business (a dealer) or buying art purely for investment (an investor). Nonetheless, collectors are increasingly motivated to buy art as an investment, and it is likely that a collector can sustain the burden of proof that he does acquire art as an investment and qualify for like-kind exchange treatment. The determining factor is the collector’s intent at the time of the exchange, not at the time of the initial purchase.

The replacement property must be of the same nature or character (rather than the same grade or quality) as the piece that is sold. Variances between artists, medium, style, and value relate to grade or quality, not nature or character, so a collector presumably could exchange a watercolor for an oil painting. Unfortunately, currently there is no specific guidance on what constitutes “like kind” for art or collectibles, although several private letter rulings (PLRs), albeit limited to their own particular facts, do provide insight into what the IRS might view as acceptable. In all of these PLRs, the replacement property was the same type as the property being sold. What is not clear is an exchange of one category for another category, and guidance should be sought from the advisor team in such cases.

A standard 1031 exchange must be set up before the sale, and a qualified intermediary must be used to hold the proceeds from the sale until reinvested in the replacement property. Once the sale has taken place, the collector has 45 calendar days to identify replacement property, and an additional 135 calendar days (180 total calendar days) to close on the acquisition of the replacement property.

A “reverse exchange” is possible, whereby the collector purchases the replacement property first, and then sells the piece to be sold within the 180-day time period. In such case, the replacement property must be “parked” with the intermediary until the exchange is complete.

In sum, selling art during life may be the right choice, but the collector must be aware that it might very well be the most expensive option from a tax and overall cost point of view.

Gifting—During Life

Gratuitous transfers—a gift during life or a bequest or other transfer at death—are subject to transfer taxes: gift tax, if made during life, and estate tax, if made at death. If the transfer is to someone two or more generations down, then the transfer is subject to a second tax, the generation-skipping transfer tax, which is assessed in addition to the gift or estate tax. The tax rate for each of these taxes is, practically speaking, 40% of the value of the asset that is transferred.

There are exceptions to these taxes. First, anyone can give $14,000 each year to each of any number of people. This amount is indexed for inflation, increased in $1,000 increments. A married couple can double this amount and give $28,000 each year to each of any number of people.

Each person also has a $5 million estate and gift tax exemption amount, indexed for inflation, called the applicable exclusion amount (AEA) ($5.45 million in 2016, twice that amount for a married couple). The AEA can be used to make gifts during life, with any unused amount offsetting estate taxes at death.

The generation-skipping transfer tax has two exceptions—properly structured annual gifts will not be subject to the tax, and there also is a $5 million exemption from the tax, also indexed for inflation ($5.45 million in 2016, twice that amount for a married couple).

From a purely tax planning point of view, a significant amount of art can be transferred without incurring any federal transfer tax. As with other assets, transfers of art can be made outright or in trust. The use of a trust may provide additional benefits but also presents some practical challenges, discussed below.

When appropriate, more advanced gifting techniques, such as grantor-retained annuity trusts (GRATs), family limited partnerships (FLPs), limited liability companies (LLCs), and transactions using grantor trusts (defective for the grantor or the beneficiary), also can be used.

The primary transfer tax advantage of making lifetime gifts of art is that the value is frozen for transfer tax purposes, and any future appreciation will not be includable in the collector’s estate.

Several important caveats and special considerations must be taken into account when attempting wealth transfer with art. This is why it is critical to know if the family cares about the art itself or the value of the art.

First, art is less liquid than many other assets. Although art certainly can be sold, the point of gifting to the next generation is with the intent that the art be kept, not sold. Because art does not produce a steady cash flow, techniques such as a GRAT or a sale to an intentionally defective grantor trust, which work especially well with assets that produce cash flow, will not work as well with art.

Second, the donee of the art will receive the donor’s cost basis in the art. This means that the appreciation that escapes federal estate taxation because of a lifetime gift eventually will be subject to federal income tax on the capital gain if and when sold by the donee. Therefore, it is necessary to compare the transfer tax savings to be achieved by the lifetime gift with potential capital gains tax that might be due. For estates less than the AEA, on which no transfer taxes will be assessed, it may be preferable to hold the art until death. The basis will be stepped up to fair market value at death, and capital gains tax on the appreciation will be avoided.

Third, discounting techniques historically have not worked well with art. Although quite effective with other assets, particularly via FLP/LLC planning, the IRS has long taken the position that art, even when transferred as a fractional gift or through an FLP/LLC structure, is not entitled to a discount for gift or estate tax purposes. Until recently, the IRS has been largely successful when taking this position with art.

The scope of this article does not permit a full discussion of the availability of discounting techniques with art and collectibles. Advisors contemplating the use of discounting techniques should become familiar with the leading cases in this area, Stone v. United States, No. C060259, 2007 U.S. Dist. LEXIS 58611 (N.D. Cal. Aug. 10, 2007), aff’d, 2009 U.S. App. LEXIS 6347 (9th Cir. Mar. 24, 2009), a federal district court case in California allowing a nominal 5% discount, affirmed on appeal to the Ninth Circuit Court of Appeals, and the more recent case, Estate of Elkins v. Commissioner, 767 F.3d 443 (5th Cir. 2014), a Tax Court case initially allowing only a 10% discount, but significantly modified on appeal to allow an approximate 45% discount.

Because there is a risk that discounting may not be available in the same manner as with other assets, collectors must examine their goals. If the primary goal is wealth transfer, then collectors are better off using other assets that are more likely to be subject to a greater discount than art. If the goal is to keep the collection largely or wholly intact, and within a family that has expressed an interest in maintaining and preserving the collection, then certain other planning techniques should be considered.

Finally, collectors should keep in mind the possibly biggest drawback to making gifts of art during life—the inability to retain possession of the art. A gift is not a gift until the donee has “unfettered access” to the gift. Making a gift, but retaining possession of the art, may run afoul of IRC § 2036, which would cause the gifted piece to be included in the collector’s estate even if ostensibly given away.

Taking these factors into consideration, the amount of art that can be transferred without paying transfer tax is significant.

Trust Structures

A significant gift of art can be made to a trust using the AEA. Additional gifts of art can be made to the trust using both the annual gift exclusion and taxable gifts above the AEA.

There are several drawbacks to making gifts to a trust, especially during the life of the collector. First, because the trust holds art, the trust will require additional funds to pay the expenses of owning and maintaining the art, including insurance. Second, as mentioned above, the collector must give up possession of the art. Otherwise, IRC § 2036 may cause the value of the art to be included in the collector’s estate. Some planning techniques attempt to circumvent the requirement to give up possession, but these techniques are beyond the scope of this article. Third, a trust owning tangible personal property will be more expensive to administer than a trust owning financial assets. These expenses are in addition to the costs of maintaining the art.

For these reasons, owning art in a trust is not the same as owning art. The aesthetic and other experiences of owning art directly are not present when the art is owned by a trust because the art may be locked away somewhere and not on the collector’s or trust beneficiaries’ walls, and the art cannot be loaned to museums. Furthermore, unless and until the art either is distributed to the beneficiaries or sold and the proceeds available for reinvestment, the beneficiaries are not going to receive any direct or immediate benefits from the trust.

Beyond standard trust structures, several types of trusts that are effective for wealth transfer also can be considered when planning with art. The scope of this article does not allow for a full discussion of these techniques, but advisors should consider the use of grantor retained annuity trusts (GRATs), grantor retained interest trusts (GRITs), and sales to intentionally defective grantor trusts (SIDGTs) to assist with the efficient transfer of larger collections. The primary challenges with all of these advanced planning techniques are first, liquidity, second, valuation, and perhaps the greatest of all, relinquishing possession of the art.

In summary, giving the art to family members during life may be the right choice. But if the goal is wealth transfer, which is different from planning with art, then a collector should consider accomplishing wealth transfer with different assets. Because of the limitations on discounting art, art is perhaps the most expensive asset for a collector to give away during life.

Donating—During Life

Donating artwork to charity is well-established. In addition to the tax benefits of donating art to charity, the collector may feel great personal satisfaction from sharing privately held art with the general public. But donating art to charity is much more complicated than one might think.

For federal income tax charitable deduction purposes, four types of assets can be donated to private or public charities: cash, ordinary income property, long-term capital gain property, and tangible personal property unrelated to the mission of the charity. Combining the type of asset contributed with the type of charity to which the asset is contributed determines the amount of the federal income tax charitable deduction.

Assume that a collector has owned the art for over one year, so that the art is long-term capital gain property. If donated to a public charity, the collector can deduct fair market value, up to 30% of adjusted gross income (AGI), and, if the art is donated to a private charity, the collector can deduct cost basis only up to 20% of AGI. Any amount in excess of the AGI limitation can be carried forward and deducted, subject to the same annual AGI limitations, for up to five years.

This deduction is subject to further reduction under the Pease limitations, which reduce certain itemized deductions by 3% of income over the threshold amount, up to 80% of the otherwise allowable deductions, when income exceeds certain thresholds.

Related-Use Rule

Art is tangible personal property, and donations of tangible personal property may be limited, depending on how the art is intended to be used by the recipient charity. If the use of the art by the recipient charity is deemed related to the charity’s exempt purposes, the donor will be entitled to a federal income tax charitable deduction at its fair market value; otherwise, the deduction will be limited to cost basis.

What is a related use? Clearly, if a painting is contributed to an art museum, and the art museum states its intention to add the painting to its permanent collection, then it is a related use. Likewise, a painting contributed to a university to be used for educational purposes, being placed in its library for viewing and study by art students, would qualify as a related use.

Compliance with the related-use rule was revised by the Pension Protection Act of 2006, which effectively restricts the donor’s federal income tax charitable deduction to cost basis if the charity sells the property within three years of receipt, unless the charity provides a certification that the property was intended to be put to a related use. This does not mean that the art absolutely cannot be sold by the charity within three years, but it means that, absent the required certification from the charity, any sale within three years of the donation will limit the donor’s federal income tax charitable deduction to cost basis.

As a result of these rules, a donation of art should be made only to a public charity or private operating foundation, and only to a charity that will satisfy the related-use rule.

Fractional Interest Rule

A long-standing technique is a donation of a fractional interest. The rules governing this technique also were modified by the Pension Protection Act. Today, for fractional interest donations, the donor must complete a gift of the entire interest in the work of art by the earlier of 10 years from the date of the first fractional interest gift or death. Successive donations of fractional interests must use the same value as the first fractional gift. Finally, the charity must take actual possession of the art for its ownership period.

It is unlikely that a museum will accept a fractional interest in artwork without the expectation that it eventually will own the entire work. Physical possession should change hands and, depending on the size and condition of the artwork, its packaging, transportation, and insurance should be agreed upon in advance. A joint-ownership agreement should be entered into and agreement reached on allocation of expenses.

With these rules in mind, consider how one can make donations of art or otherwise make art available for others in the context of charitable giving.

The simplest approach is a direct donation of art to an art museum or other qualifying charitable organization, keeping in mind the related-use rule. The collector will be entitled to a federal income tax charitable deduction equal to the full fair market value of the donated art, up to 30% of AGI, with a carryforward of any excess for up to five tax years.

A donation of a fractional interest in art is still feasible as long as the collector understands and complies with the fractional interest rules. If the art is a piece that the collector intends to give the museum eventually, it may make sense for the collector to make a donation of a fraction of the art and loan the remainder of the art to the museum. The problem of moving the piece back and forth when damage is most likely to occur is avoided, and the collector then can make further donations of fractional interests, timed to most efficiently use the federal income tax charitable deduction.

Charitable remainder trusts (CRTs) are popular income tax planning tools, but they do not work particularly well with art. First, a federal income tax charitable deduction is not available until the art is actually sold. Second, the gift will always fail the related-use test, so the deduction, when available, will be limited to the lesser of fair market value or cost basis. Finally, CRTs must allow the trustee to reinvest the trust principal into productive assets, which means that a CRT formed to hold art probably will not qualify as a CRT. This is not to say that there are not times when a CRT might work, but such times will be few and far between.

Charitable lead trusts (CLTs) are powerful income and estate and gift tax planning tools. When planning with art, CLTs are more commonly established by the donor’s will rather than during life.

Your Own Museum

For a number of reasons, a collector may not wish to transfer his collection to an existing museum. Perhaps the collector cannot find a museum suitable for the collection, or the collector is not comfortable with the conditions imposed by any suitable museum for accepting his collection.

Still, because of the significant costs of establishing and maintaining a museum, collectors first should consider existing museums, even if it means paying to build a separate wing onto an existing facility to house and guarantee the integrity of the collection.

If this is not possible, then the collector may wish to form his own museum. If the collector wishes for the museum to be a tax-exempt organization and to receive a federal income tax charitable deduction for contributions to the museum, then the museum should be formed as a private operating foundation (POF). The museum will be considered a “private foundation” because it is being funded by one person or family and will not meet the tests required to qualify for public charity status. The museum will be considered “operating,” however, because it actually will conduct charitable activities and not only provide grants to other operating charities.

A POF is a hybrid entity, and because it is operating a charitable activity, a POF will be treated much like a public charity for federal income tax purposes, and the donor-creator will be entitled to a federal income tax charitable deduction equal to the fair market value of the collection that is given to the POF, subject to the 30% AGI limit in any one year. A donation of art to a POF will tend to be a large donation, so it may make sense for the collection to be contributed over time to stagger the deduction to be more efficiently used against the income of the collector. It is possible that some works will be contributed and others loaned for a period of time, or perhaps fractional interest gifts made, to arrive at the most income-tax-efficient solution.

A POF must meet its own special set of rules to qualify as such. Although highly technical, the rules in actuality are not difficult to meet for someone who wishes to organize and operate a legitimate museum.

Selling—At Death

The sale of art at the death of the collector (or surviving spouse) is likely the most common scenario, either by design, or because the collector could not or would not part with the art while alive, or because the collector would not engage in the planning process while alive.

From a tax planning point of view, the biggest advantage to selling art at the collector’s death is that the cost basis in the art will be stepped up to its fair market value. As a result, the 28% long-term capital gains rate for collectibles and the 3.8% health-care surtax are not relevant, except for postdeath, presale appreciation. In fact, with the now permanent, larger AEA, for most people, a sale at death, rather than a sale during life, will provide the best overall tax outcome.

The biggest drawback to selling at death is not tax-related and is the fact that the person who knew the most about the collection is no longer around. This drawback can lead to major issues if meticulous records have not been maintained. Furthermore, it will be necessary for the personal representative of the estate to either be knowledgeable about the art or be able to retain someone who is. Otherwise, the art may be sold for much less than its actual worth.

It will be necessary for the collection to be appraised if the estate is above the AEA, because an appraisal will be required to be filed with Form 706. Even if an appraisal is not required, it is still good practice to have an appraisal prepared to give the personal representative an idea of the price at which the pieces should be sold.

If the art is sold at death, it is included in the estate and is subject to the federal estate tax system and a 40% federal estate tax rate (plus any applicable state estate taxes) above the AEA. The taxes can give rise to liquidity issues, and some or all of the art may need to be sold to provide liquidity to pay estate taxes and other costs of maintaining the collection during estate administration or to make cash bequests or other distributions.

Expenses of the estate to sell art are deductible if the sale is necessary to pay debts, expenses, or taxes, to preserve the estate, or to effect distributions. A provision should be included in the estate planning documents that directs that any art not bequeathed or selected by beneficiaries be sold and the proceeds distributed, ensuring the availability of the deduction under IRC § 2053. The executor will need to elect whether to deduct these expenses on the federal estate tax return or the estate’s fiduciary income tax return.

Although a sale at death is perhaps the most common disposition of art, and perhaps the best one from a federal income tax point of view, it is potentially the most difficult option if the collector has not planned properly.

Gifting (Bequeathing)— At Death

There are two basic ways to complete an estate plan: using a will with dispositive provisions or using a pourover will and revocable trust with dispositive provisions in the revocable trust. In either case, the general pattern of estate disposition is “A-B funding,” with the “A” share representing the amount of the marital share (assuming there is a surviving spouse), and the “B” share representing the unused AEA. As with other planning techniques, many variations of this pattern exist, and this pattern has become even more complicated with the addition of portability of the AEA to the transfer tax system.

For a collector, it often is advisable for him to use the revocable trust structure and actually transfer his art, or interests in an LLC owning art, to the revocable trust. Probate varies from state to state, and using a funded revocable trust will minimize the effect of probate and help to maintain privacy. During his lifetime, the collector maintains complete control and flexibility over the art, and he can provide for successor management should he become incapacitated. A revocable trust also will allow the successor trustee to make decisions about the management of the art without probate court involvement.

The revocable trust becomes irrevocable at the death of the collector and can control the disposition of the collector’s art. To the extent that disposition is directed over certain pieces, these directions can be changed much more easily during the collector’s life by amending a revocable trust than by amending a will.

A bequest of art should be clear and unambiguous to avoid conflicts among beneficiaries. A bequest of art “in equal shares” more often than not will lead to disputes among beneficiaries. Likewise, leaving the decision to the personal representative also will likely lead to disputes.

Perhaps a better solution is for the collector to leave specific items to specific beneficiaries or to provide that beneficiaries have the right to select items of art as they wish, and the balance to be sold. The collector perhaps can set forth a process to determine an order of selection, say oldest child gets first choice, then second oldest, and so on, with equalizing distributions made from other assets.

Some question exists about the proper federal estate tax treatment when a surviving spouse is included in this process. Normally, the estate is entitled to a marital deduction for whatever passes to the surviving spouse. Whatever passes to the surviving spouse, however, cannot be a “terminable interest,” except when it is to a “qualified terminable interest trust,” commonly known as a QTIP trust.

If the surviving spouse is given a first right of refusal to select among the artwork, there is some question whether this is a terminable interest. If so, the marital deduction would not be available. To avoid this issue, it is best to make a specific bequest of certain items to the surviving spouse. If the collector gives the surviving spouse a right of first refusal, however, it should be limited to the time period permitted for a qualified disclaimer.

Perhaps a better option is a bequest of all of the art to the surviving spouse, with the ability of the surviving spouse to make a qualified disclaimer. The greatest challenges with this option, just as with any disclaimer planning, are, first, to ensure that the surviving spouse does not take any action that would disqualify the disclaimer and, second, to make sure that any required action is taken within the disclaimer time period. Because the disclaimer would be of tangible personal property, which likely is located in the home, the disclaimer is much more difficult than one of intangible assets. It is possible to do this planning, but it is somewhat risky from a practical point of view.

Trust Structures

The previous planning options assume an outright distribution of art to the beneficiaries. But it may be that a disposition at death will include transfers to trusts established during life or to new trusts created at death. In such cases, several important decisions must be made.

If the makeup of the collector’s estate is such that it will be necessary or desirable to include the art in the A-B funding, then it most likely will make sense to fund the B trust with the art, as art tends to be the type of asset—appreciating, but with no steady income—that is better for funding the B share.

If a trust is used, it is imperative to retitle the art to the trust, and the change in ownership should be reflected on insurance policies and inventories. Also, physical possession of the art must be considered. If beneficiaries are allowed to possess and display the art, the trustee must confirm that appropriate insurance coverage is in place, that the beneficiaries’ residence or other place of display is appropriately secure, and that other risk-management practices are being followed. And, of course, the trust must be funded with sufficient liquid assets to ensure the trustee’s ability to continue to pay expenses associated with the art.

Donating—At Death

Donating art to charity at death, rather than during lifetime, is a much simpler process, at least from a federal tax point of view. All of the federal income tax charitable deduction rules discussed above do not apply to testamentary donations. Individual pieces of art or the entire collection—whatever the collector decides to bequeath at death—are delivered to the charity, and the collector’s estate receives a federal estate tax charitable deduction based on the current value of the artwork. The amount of the deduction must be an ascertainable value and it must be supported by an appropriate appraisal.

Just as with sales and bequests to family members at death, the advantage of waiting until death to transfer artwork to charity is that the collector can continue to possess and enjoy the artwork during life.

From a federal tax planning point of view, the biggest drawback of waiting until death to give art to charity is that the collector forfeits the federal income tax charitable deduction that would have been available if the art had been donated during life.

It is important that the collector specifies in his estate planning documents—or preferably, in an agreement reached with the charity during life—any special conditions. Will the art become part of the museum’s general collection or will it maintain a separate identity? Can the art be sold? Will it be on permanent display? Is the museum permitted to lend the art to other institutions? Will additional funds be required to maintain the collection? These conditions can, and should, be negotiated while the collector is alive, even if the art will not be delivered until after the collector’s death. Care must be taken that the conditions are acceptable to both the collector and the charity and are not so restrictive as to jeopardize the federal estate tax charitable deduction. Absent such an agreement, it is possible that the charity named in the estate planning documents might reject the donation.

The simplest way to donate art to charity at death is a direct donation. Other techniques, however, also are available for donations of art at death. These include bargain sales (enhanced because of the basis step-up at death) and even loans, if the estate planning documents empower the personal representative to enter into, or continue, loans of the art. Also, certain charitable planning techniques that do not work particularly well during life, because of the federal income tax charitable deduction rules or simple economics, may work well for donations at death.

Testamentary CRTs are not subject to the related-use rule or delayed federal income charitable deduction applicable to lifetime CRTs. A testamentary CRT trustee still must be able to invest in income-producing assets. Therefore, testamentary CRTs make sense only when a sale of a portion or all of the collection is contemplated.

CLTs funded with art may be more useful if established at death rather than during life. The CLT can be structured to provide the collector’s estate with an immediate estate tax charitable deduction for the full value of the art placed in the CLT. Assuming that the CLT sells the art shortly after funding, reinvests the proceeds, and earns an investment return in excess of the IRC § 7520 rate in effect at the time of funding, the excess earnings will pass transfer-tax-free to the collector’s named CLT beneficiaries.

It should be noted that using either CRTs or CLTs in this context contemplates a sale of the art, rather than a donation of the art to charity. As such, these techniques are used more for tax savings than pure art planning.

POFs also can be established at death, although it is preferable to establish them during life. A lifetime transfer allows the collector to receive a federal income tax charitable deduction and, perhaps more importantly, be alive to see his dream come true.

Ramsay H. Slugg

Ramsay H. Slugg is a managing director and member of the National Wealth Planning Strategies group at U.S. Trust, Bank of America Private Wealth Management. Any case studies are presented for illustration and do not necessarily reflect specific strategies that may have been developed for collectors. Any case studies are for illustrative purposes only and are not intended to serve as specific tax advice, since the availability and effectiveness of any strategy are dependent on a client’s individual facts and circumstances. Results will vary, and no suggestion is made about how any specific solution or strategy will perform in reality.