W E A LT H M A N A G E M E N T
WEALTH
PLANNING
WITH
ART
WEALTH PLANNING WITH ART
Art. It inspires us. It intrigues us. We celebrate art and artists
globally – from EXPO Chicago to Art Basel Miami and Hong
Kong. Whether you view art as a passion or an investment, or
perhaps a bit of each, today’s vibrant art market and the surge
in private gifts of art touches many of our lives.
In this Insights on Wealth Planning we explore considerations
of interest to those with an affinity for art. Wealth planning and
management related to art offers many opportunities, but it is
also quite nuanced. The art environment is diverse and
constantly changing; acquiring, managing, valuing and
ultimately disposing of works of art requires thoughtful
planning and the advice of trusted experts and advisors
in order to realize the full value of an individual work or
collection. We encourage you to confer with your art,
legal and tax advisors as to matters pertaining to your
particular circumstances.
3
ART MARKET TODAY
The global art market achieved total sales of $63.8 billion in 2015, falling seven percent
year-over-year from its previous highest-ever $68.2 billion in sales in 2014.1 This was the
first year of decline since 2011. Despite the sudden reversal in the global art market, led
primarily by China’s 23% decline in sales to $11.8 billion, the United States secured its
position as top dog with sales up four percent in 2015 to an all-time-high of $27.3 billion,
comprising 43% of global market share by value. The substantial growth in sales of art
over the decade has been facilitated by the globalization of the art market, and has
been propelled by an exceptional increase in wealth, especially in emerging art markets
such as India, Russia, the Middle East and Latin America.2 The increase in the number of
ultra-high net worth individuals globally has substantially contributed to the demand for
buying and investing in artwork.
The art market is heavily polarized, with the trophy works by well-known modern, postwar
and contemporary artists comprising the bulk of transactions by dollar value. During 2015,
the top sales at auction occurred primarily during the first half of the year, with the top ten
sales fetching over $2 billion total, with a number of record-setting figures. Some of the
top artists (measured by sales) at auction in 2015 include:3
Artist
PABLO PICASSO
Sales at Auction
$441
309million
total
CLAUDE MONET
$289
309million
total
ANDY WARHOL
$288
309million
total
ALBERTO GIACOMETTI
$204
309million
total
MARK ROTHKO
$181
309million
total
GERHARD RICHTER
$152
309million
total
FRANCIS BACON
$150
309million
total
CY TWOMBLY
$113
309million
total
JOAN MIRÓ
$97
million
309
total
AMEDEO MODIGLIANI
$170
309million
total
Wealth Planning with Art
Art transactions rest on a limited cadre of participants. Of the 38.1 million art transactions
recorded in 2015, 28% of sales were of pieces at prices over $10 million, comprising
only 0.1% of transactions overall. Specifically, 8% of the art sold at auction worldwide
accounted for 82% of the market by value. Concentrated interest in the works of a
relatively small number of artists and those high-priced sales skew the data toward those
artists.4 Picasso’s Les Femmes D’Algers (Version “O”) (1955) sold at Christie’s in May
2015 for $179 milion, becoming the most expensive work ever sold at auction.5 During
the same sale, Giacometti’s L’Homme au Dougt (Pointing Man) (1947) fetched $141.2
million, claiming the top spot for the most expensive sculpture ever sold at auction.
Another notable sale was Richter’s Abstraktes Bild (1986), which sold for $46.3 million at
Sotheby’s London in February 2015 and took the record for most expensive painting by
a living European artist.6 The same Richter work previously sold for $607,500 in 1999.
In 2015, a striking 90% of the top two hundred collectors are collecting contemporary
and postwar art (typically defined as art created during one’s lifetime), up from 58% in
1990.7 Contemporary and postwar works made up the largest segment of auction sales
worldwide, reaching approximately $6.58 billion, comprising 48% of all sales by value.8
Sales in this segment made up 72% of the value of all auction sales at New York City
auction houses in 2014, up 11% from 2013.
THE ART RELATIONSHIP
Artists, investors, hobbyists, business collectors and dealers each have slightly different
relationships with art and those relationships have wealth planning and management
implications. There are some common understandings of the various categories of
holders of art.
• Investors buy, sell and collect art as an investment with the hope the art will appreciate
enabling a profitable sale.
• Hobbyists collect art for personal pleasure, rather than focusing on whether the art
will ever become a profitable investment.
• Dealers buy and sell art as a trade or business.
• Business collectors buy art, not for resale, but for business use, such as for display
in a workplace.
An individual may have different relationships with various artworks and may have a
blended relationship with a single piece or collection. Increasingly, high-net-worth
individuals acquire art, not only for personal satisfaction, but also with an investment
outlook. It is estimated that the individual art investor currently allocates approximately
10% of his or her portfolio assets to art and collectibles.9 It is not particularly surprising
therefore, that 76% of art collectors view their art acquisitions and collections as both
a passion and as an investment, up from 53% in 2012.10 Although many may view their
art partly as an investment, only 3% of collectors surveyed said their acquisitions were
purely investment-motivated, with 61% responding that the social value of buying art
was a key motivation for collecting.11
5
THE VALUE OF ART
Looking beyond the headline auction sales, there are a number of important challenges
in determining the value of art apart from aesthetics. There is no public, regulated,
transparent, real-time marketplace for art as there is for publicly traded securities. The
factors that impact the value of art are varied, accompanied by a degree of associated
risk and uncertainty. Determining a work’s value may be difficult, especially if the piece
is unique, rare or does not have an established retail market. Valuation may be especially
difficult if a work is part of a larger collection, was commissioned or is by a lesser
known artist.
Supply and demand are determinants of price in markets generally. However, a number
of other forces unique to the art market will have a material influence on both the value
of a particular work or collection and the price obtainable in the market, including
authenticity, provenance, title, rarity, condition and government restrictions on trade.
AUTHENTICITY
Authentication is the starting point for determining the value of your art collection. In
most cases, the authenticity of goods that trade on a secondary market can be readily
verified and permanently relied upon. The authenticity of a work of art, however, is not
a permanent condition; rather, it is a consensus opinion at a point in time, and can
and does change.12 Scenarios giving rise to authenticity concerns are typically forgery,
misattribution and modification. A forgery is an intentional deception. Misattribution
is the mistaken opinion of the seller that the artwork is by the artist in question.
Modification generally occurs when the owner seeks to restore the artwork and in so
doing, modifies it.13
A major risk associated with investing in art is that a work could turn out to be
fake, forged, stolen or questionably obtained. For a collector, it is critical to establish
the authenticity of a particular piece. Authentication by a reputable and unbiased
independent expert is often desirable and serves as a verification of authenticity for
the buyer who wants confidence that the item he or she is bidding on at auction or at
private sale is authentic.14 Because of the risk that a major acquisition could actually be
worthless, buyers should conduct their own due diligence whenever possible before
purchasing a piece, and should be wary of accepting a piece as authentic simply
because of its supporting documentation. Remember, documents can be forged too.
Wealth Planning with Art
PROVENANCE
Provenance is a clear and definitive indicator for determining value. Provenance is the
origin or source from which a particular work has come to the market, and refers to the
work’s ownership history, various auction records, conservation records, certificates
and bills of sale. A record of provenance gives buyers reassurance regarding the work’s
value and provides a verifiable public certification of authenticity.15 The ownership
history can have a marked effect on the valuation of a piece. For example, a Cartier
ruby and diamond necklace given to Elizabeth Taylor by Richard Burton was appraised
at $200,000-300,000, but sold at auction for almost $3.8 million based on the special
circumstances of its provenance.16
GOOD TITLE
In transferring a piece of artwork, whether by sale or gift, you must be able to defend
its title. A piece of artwork might be subject to various liens, serve as security for a loan
or be subject to a legal claim. Additionally, stolen art creates difficult legal issues for the
unsuspecting collector. Artwork that crosses international borders may have more than
one legal system at play as countries have different laws as they pertain to purchasing
stolen artwork.
A war-looted work not only impairs good title, but could also be subject to future legal
controversies. When dealing with artwork with WWII-era provenance, for example, you
should be sure to collect as much information as possible to avoid purchasing war-looted
art. Title issues involving war-looted art arise more frequently than one might expect. For
example, a Picasso painting, Portrait of Angel Fernandez de Soto, then owned by the
Andrew Lloyd Webber Foundation, was estimated to fetch between $40 million and $60
million at auction, was withdrawn from a 2006 Christie’s auction sale because of a claim
that it had been transferred under duress by a Jewish owner in Germany to an art dealer
in Switzerland in 1935.17 The legal challenge was subsequently resolved, and in 2010,
Christie’s presented the piece at auction, selling for over $51 million.
RARITY
Rare art objects often translate into higher values. For example, if an artist has created a
relatively small number of works, and the artist is considered of major importance, each
individual work will likely be highly sought after and consequently expensive. However,
this is not always the case. Rarity can negatively impact value if the work does not reflect
the current market taste, making the piece less desirable.
7
CONDITION
Maintaining a work’s good condition is crucial to maintaining its value and is simply
effective asset management. Collectors should take care to properly store artwork in
order to facilitate its preservation. Musty rooms, direct sunlight and displaying paintings
over fireplaces are examples of ways in which the work’s condition can be compromised
over time, even though the work appears flawless to an untrained eye.
GOVERNMENT RESTRICTIONS
A number of countries, including the United States, impose restrictions on the trade in
certain items that may adversely affect U.S. collectors. The Convention on International
Trade in Endangered Species of Wild Fauna and Flora (CITES), for example, is an
international agreement between 181 countries, including the United States. The CITES
governs the international trade in certain wild animals and plants so that their survival
is not threatened. The United States is also subject to stricter restrictions enacted under
its Endangered Species Act of 1973 (ESA). The ESA restricts or prohibits the movement
of endangered or otherwise protected plants or animals and related items such as
feathers, corals, ivories, tortoiseshell, walrus, seal and certain types of woods.
APPRAISING ART
One may assume they know the value of the works in their collection or are able to
gauge value based on prices they observe in the art market, but that is seldom the
case. Knowing the value of your artwork is of utmost importance for a host of
reasons, including:
• Determining and maintaining appropriate types and levels of insurance coverage;
• Making gifts to charity and substantiating any associated income tax deduction;
• Making gifts to family and others and complying with any applicable gift tax
requirements;
• Settling the estate, including making distributions and determining estate taxes;
• Engaging in art-based lending transactions; and
• Engaging in sales and exchanges and the related tax reporting.
The purpose of an appraisal will guide the selection of the appraiser and the requirements
of the appraisal itself. It is important to work with a qualified appraiser who understasnds
the purpose of the requested appraisal and who regularly deals with the type of
property being appraised. Working with a qualified appraiser will help ensure that
certain required information is included in the appraisal as the requirements may vary
depending on its use.
Wealth Planning with Art
APPRAISALS FOR INSURANCE PURPOSES
Insurance appraisals are prepared as a risk-management measure to protect art
assets in case the collection should fall victim to theft, accidental damage, fire, flood
or any other unfortunate situation. Insurance appraisals are generally based on retail
replacement value (RRV). The RRV is the amount of money it would cost to place an
item with a like item of similar quality, in a retail venue and within a relatively short period
of time. The RRV will likely be higher than the fair market value used for tax-related
purposes, discussed below, because RRV reflects the price one would have to pay to
replace the item at retail, such as at a high-end gallery.
APPRAISALS FOR TAX PURPOSES
If an appraisal is for tax-related purposes, Treasury regulations are generally consistent
in their approaches to the valuation of artwork for income, gift and estate tax purposes.18
Unlike the retail replacement value used for insurance purposes, the value for tax
purposes is the work’s fair market value at the time of the contribution or transfer, either
during life or at death.19 Fair market value for tax purposes is “the price at which such
property would change hands between a willing buyer and a willing seller, neither
being under any compulsion to buy or to sell, and both having reasonable knowledge
of relevant facts.”20 This value is based on a hypothetical sale in the market in which the
artwork is most commonly sold to the public – at auction. However, if the artwork is
unique, rare or part of a larger collection, the regulations’ contemplated “retail market”
may not exist.
Not surprisingly, taxpayers and the Internal Revenue Service (IRS) at times have differing
views of the value of a work of art. The Art Advisory Panel of the Commissioner of
Internal Revenue (the Panel) provides advice to the Art Appraisal Service unit in the
Office of Appeal of the IRS. The Panel’s charge is to help the IRS review and evaluate
the tangible personal property appraisals submitted to the IRS to support the values
reported for tax purposes. Objectivity and taxpayer privacy are priorities. Although
the Panel’s recommendations are advisory, the IRS adopted 74% of the Panel’s
recommendations in full in Fiscal Year 2015.21
Charitable Gifts – Appraisal requirements of art for income tax deduction purposes
are somewhat more involved than for gift or estate tax purposes. The income tax
regulations articulate clear requirements for an appraisal to be a “qualified appraisal.”
For any contributed work of art valued in excess of $5,000, you, as the donor, must
obtain a qualified appraisal from a “qualified appraiser” within 60 days of the
contribution date.22 A qualified appraiser must be an individual who holds himself or
herself out to the public as an appraiser or performs appraisals on a regular basis and is
qualified to make appraisals of the type of property being valued.23 Thus, an appraiser
who specializes in Chinese pottery from the thirteenth century may not be qualified to
appraise a Monet watercolor under the guidance provided by the regulations.24
9
ART ADVISORY PANEL FISCAL YEAR 2015 COMPREHENSIVE RECOMMENDATIONS REPORT
Number of Items
(% of Total Items
Reviewed)
Type of Adjustment
Taxpayer
Claimed Value
Panel
Recommendation
Net Change
(Panel Less Claimed
Value)
TOTAL ITEMS INCREASED
198 (44%)
$314,991,344$478,753,000$163,761,656
TOTAL ITEMS DECREASED
92 (21%)
$151,140,892$101,505,000($49,635,892)
TOTAL ITEMS ADJUSTED
290 (65%)
Not applicable Not applicable
Not applicable
TOTAL ITEMS ACCEPTED
156 (35%)
$183,163,985
$183,163,985
Not applicable
446 (100%) $649,296,221
$763,421,985
$114,125,764
Not applicable $1,455,821
Not applicable
Not applicable
TOTALS
AVERAGE CLAIMED VALUE PER ITEM
Further, a qualified appraiser must be fully independent, meaning the appraiser cannot
be you (the donor), a party to the transaction in which you acquired the artwork (e.g.,
an employee of the gallery that sold the artwork to you) or anyone “related to” you, as
defined by the regulations. Further, if you have any information that would lead you to
believe that the appraiser would falsely state the value of the contributed work, then that
appraiser is not qualified. Additionally, a qualified appraiser must have a designation
from a recognized appraiser organization, such as the Appraisers Association of America,
and must not have been banned from practicing before the IRS at any time during the
three-year period ending on the appraisal date.25
The appraisal itself must contain certain information in order for it to be a qualified
appraisal. Some, but not all, of the required information includes:
• A description of the artwork;
• The expected donation date;
• Identifying information about the appraiser (including name and address);
• The date on which the artwork was appraised; and
• The appraised fair market value of the artwork.26
Wealth Planning with Art
Donors of artwork must conduct their due diligence to select a legitimate, qualified
appraiser, as the consequences for failing to do so can be severe, including loss of the
entire charitable deduction and/or fines.27
Non-charitable Gifts and Bequests – Obtaining a current valuation is also important
for gift tax purposes if you gift works during your life and for estate tax purposes if the
works are owned at death.
The difficulty of valuing art for gift and estate tax purposes is often complicated by the
fact that a work of art is often held as part of a larger collection.28 For example, renowned
artist Georgia O’Keeffe died owning a collection of approximately 400 works of art. The
IRS agreed with the estate that at the time of O’Keeffe’s death in 1986, the individual
fair market values of the works totaled $72 million. Subject to dispute, however, was the
estate’s claimed “blockage discount” attributable to the fact that so many of the works
of art in the collection could not be sold in bulk for the price that individual pieces would
sell for if sold over an extended period of time.29 The blockage discount, therefore,
recognizes for transfer tax purposes the realities of a huge number of works of art
coming on the market for sale at the same time, disrupting the normal economics of
supply and demand. The Tax Court settled the dispute between the O’Keeffe estate, with
the IRS applying a 37% blockage discount.
Although the blockage discount in O’Keeffe was applied for estate tax valuation
purposes, the discount would also be appropriate for valuing for gift tax purposes a
lifetime gift of a collection of art. Other valuation discounts, such as the discounts for
lack of marketability or control, may be applied in order to determine the fair market
value of a transfer of art for gift and estate tax purposes in cases where, for example,
the transfer is of an interest in an entity owning the artwork or where a collection is
transferred subject to various restrictions on partition, alienation or possession.30
Although the income tax rules require a “qualified appraisal” by a “qualified appraiser,”
the estate tax rules require only an appraisal accompanied by a sworn statement
made by the executor of the estate containing an itemized list of the appraised
works of art and a declaration as to the appraiser’s disinterested character and his
or her qualifications.31
No similar regulation applies to gifts of art under the Federal gift tax. Nonetheless, if you
make a charitable gift of art and want to begin the running of the statute of limitations
on the gift in order to prevent a revaluation by the IRS at a later date, the gift must
be “adequately disclosed.” Adequate disclosure may be made either by providing a
detailed description of the method used to determine the fair market value of property
transferred or by submitting an appraisal of the gifted property that meets the detailed
requirements set forth in the regulations.32 These requirements are similar in scope
and extent to the qualified appraisal requirements that apply for charitable income tax
deduction purposes.
11
Advance Valuation Ruling Procedure – In an attempt to avoid the time and expense
involved in disputing art valuations, a procedure exists enabling a taxpayer to obtain
an advance ruling from the IRS as to the value of art for income, gift or estate tax
purposes.33 For a transfer of a work of art that has been appraised at $50,000 or
more, a Statement of Value may be obtained from the IRS for the item prior to filing
the appropriate tax return that first reports the transfer.34 Working with a reputable
appraiser will ensure that all of the advance ruling procedure requirements are met
prior to submitting the request. Once the IRS issues a determination of value under
this procedure, it must be attached to the applicable tax return and it is binding on the
IRS. If the taxpayer disagrees with the determination, he or she may submit additional
information with the appropriate return to support an alternate valuation. This procedure
would be advantageous to a taxpayer who desires certainty when filing his or her return.
THE GIFT OF ART
A MATTER OF LIFE OR DEATH?
You may desire to pass on your passion for art by gift, to charity, family or friends, but are
uncertain as to when you would like to make your gift. There are a number of advantages
associated with both lifetime and testamentary gifts.
Advantages of Lifetime Gifts – A transfer made during life will remove the art from
your estate, which may be advantageous for a few reasons. First, the value of the art is no
longer part of the estate, reducing the value of the estate and thus the amount of estate
taxes that may be due upon your death. Second, any further appreciation in the value of
the art occurs outside of your estate. If you wish to transfer art to a spouse, a lifetime gift
may make more sense than a testamentary gift in some instances. A spouse can make
unlimited transfers of assets (including art) during life to a U.S. citizen spouse without
triggering Federal gift taxes. If one spouse has significantly more wealth, transferring art
during life can reduce the value of the taxable estate of the first-to-die and help equalize
wealth between the two spouses.
Advantages of Gifting at Death – One of the most important benefits of transferring
appreciated art to family or friends at death is the possibility of a step-up in basis to fair
market value. Generally speaking, when property transfers at death, the recipient’s basis
in the property is equal to the value of the property on the date of the decedent-owner’s
death. If you transfer art that has appreciated in value at death, the recipient may then sell
the art without realizing some or all of the built-in gain as a result of the step-up in basis.
However, it is important to remember that the value of the appreciated art will still be
included in the value of your gross estate.
Another benefit to transferring art at death is that you will be able to own and enjoy
the art until your final day. For many collectors, art is a passion asset that brings a great
amount of joy. Waiting until death to transfer the art allows you to continue to enjoy your
art in the comfort of your home.
Wealth Planning with Art
Transferring art at death may also allow you to more effectively achieve your charitable
giving goals, depending on those goals and the organizations you wish to support.
The related use rule, discussed below, does not usually apply to transfers of art from a
decedent-collector’s estate. For example, a collector may wait until death to transfer a
prized painting to a local soup kitchen or homeless shelter so that the estate can take
a charitable deduction for the full fair market value of the painting. It is worth noting,
however, that this technique may not be available for artists who wish to transfer their
own self-created art to charitable organizations at death due to complexities with
copyright interests. Therefore, it is important that artists consult with experienced
attorneys and tax advisors on charitable planning with art.
GIFTS TO CHARITY
Many philanthropists are motivated to make charitable gifts because they have a desire
to make a positive impact in their communities or support specific organizations.
In addition to having an interest in making a positive impact, many donors are also
interested in obtaining a deduction on their personal Federal income taxes. In order for
a donor to optimize, there are many factors to consider.
Type of Property Contributed – In order for you to obtain an income tax charitable
deduction equal to the full fair market value of contributed art, the art must be considered
capital gain property. Generally speaking, you must have owned and held the art for
more than one year, the work of art must qualify as a capital asset, the art must have
appreciated in value and the art must be a “collectible” as defined by the Internal
Revenue Code (Code).35
If the art is considered ordinary income property, your deduction will limited to the basis
in the art, which generally means the cost of the materials used to create the art. The art
may be considered ordinary income property if it was: (1) created by you, the donor; (2)
received by you as a gift from the creator; (3) held as inventory by an art dealer; or (4)
owned for one year or less at the time it is donated.36 Thus, artists and those who receive
gifts of art directly from an artist should take note of the fact their pieces will likely be
categorized as ordinary income property.
Type of Organization Receiving the Gift – In order for you to obtain an income tax
deduction equal to the full fair market value of the art, the art must be contributed to
an organization that will use the art in a way that relates to the organization’s charitable
mission. This requirement is often referred to as the “related use” test. A classic example
of a donation of art satisfying the related use test would be a gift of a painting to a fine
art museum. If a donation of art fails to meet the related use test, the deduction will be
limited to the cost basis.
13
In some instances, a contribution of art will never satisfy the related use test.
For example, if you contribute your art during life to a private foundation or a
charitable remainder trust the related use test will not be satisfied because those
tax-exempt entities do not have charitable purposes related to art. Therefore,
it is important for you and your advisors to consider the type of organization
receiving a donation of art before making such a gift.
Appraisal of the Contributed Art – While the old adage that “beauty is in the eye
of the beholder” reflects the subjective nature of art, we may need a new adage
that “value is in the eye of the appraiser” to reflect the importance of an objective,
qualified appraisal when discussing charitable gifts of art. The requirements
for art appraisals for charitable income tax deduction purposes are discussed
at length above. As a reminder, donors of art looking to maximize their current
income tax charitable deduction must follow the complex IRS rules carefully.
Working with trusted advisors can make the process easier, and help ensure your
tax goals are aligned with your philanthropic goals.
CHECKLIST FOR NON-CHARITABLE
TRANSFERS OF ART
• Obtain a qualified appraisal prior to
making the transfer.
• Provide all documentation pertaining
to provenance (if applicable).
• Transfer title to new owner.
• File gift tax return and pay any
applicable gift taxes.
Communication with the Donee – While an income tax charitable deduction may
be an important consideration for you in contemplating a charitable gift of art, it is by
no means the only consideration. Donors often have strong motivations for making a
charitable gift of art, such as a desire to safeguard art and preserve it for subsequent
generations to see and enjoy. But before making such a gift, you should work with
potential donees to ensure goals and expectations are realistic and aligned for
both parties.
If you are thinking of leaving art to one or more nonprofit organizations in your will or
estate plan, it is a good idea to let those organizations know of your intentions while
you are still alive. First and foremost, it is important to know whether or not a museum
or other nonprofit organization is interested in receiving your art as a gift. If a cherished
work of art does not fit within a museum’s curatorial or accession plan, the organization
may pass on the gift. That may not only thwart your philanthropic goals, but it may leave
the executor of your estate with the task of figuring out a “Plan B.”
Work with an Advisor on a Gift Agreement – Communicating in advance with an
intended donee allows you to express your wishes for how you would like the organization
to manage your gift. For example, you may want a donated piece of art displayed for
a certain period of time by the recipient. Assuming you and the donee can come to an
understanding around accepting a donation of art, it is a good idea to have a written gift
agreement in place to document the details of the transaction.
Gift agreement templates may be easily accessible online, but it is worth the time and
expense to work with an experienced attorney or philanthropic advisor to develop an
agreement that accurately represents the goals and expectations of all parties.
Wealth Planning with Art
Consider Making a Gift of Cash or Securities Along with Gifts of Art – Along with your
art, you may also want to consider making an additional gift of cash or marketable
securities as a way to help the recipient organization manage the donated art. There are
a number of expenses that may be associated with properly caring for and protecting
art, including insurance, storage, restoration and transportation. It would be wise for
you to discuss these associated costs with potential donees. In certain circumstances,
you may wish to make an additional gift of cash or appreciated securities to help offset
some of the associated costs.
GIFTS IN TRUST
It may make sense for you to transfer art out of your estate during life in order to reduce
the size of the taxable estate. But what if you do not have any individuals or charitable
organizations identified to receive the art? Or, what happens if you want to transfer art to
a family member or friend, but you have certain conditions that you want to place on the
transfer? Transferring art to a trust may be a solution in these circumstances.
If you want to safeguard multiple pieces of art for future generations, but are not yet
ready for your children or grandchildren to take possession of your collection, making
an irrevocable gift of the art collection to a trust may be an effective transfer technique.
But before making the transfer, you should carefully consider the terms of the trust,
decide who will act as the trustee of the trust and consider the responsibilities the trustee
will have to undertake. For example, a trustee of a trust owning art may have to consider
where to store the art, appropriate insurance levels, if and/or when the art can be loaned
or sold and how often to have the art appraised. Further, the trust may need additional
liquid assets to pay insurance premiums, storage costs and other related expenses.
Once the art is held in trust, the trust document will dictate how the art is managed and
ultimately transferred. In the trust provisions you can name specific individuals to receive
specific trust assets (such as specific works of art or sculpture), or the trust may direct the
trustee to choose which beneficiaries receive the pieces of art held in trust. If you intend
to transfer your art into trust, you should work with an experienced attorney to draft
the trust document, and be very thoughtful about selecting a trustee with experience
in managing art. In some instances, it may be a wise choice to select a corporate or
institutional trustee to manage art transferred to trust.
Regardless of whether you make a direct transfer of art to a family member, or if you
use a trust to transfer art to subsequent generations, it is vitally important to work with
advisors who have experience in estate planning with art. The rules can be complex, and
it is easy to get tripped up in the planning. As you have already spent a lifetime obtaining
cherished works of art, it is usually worth the time and expense to work with professional
advisors who can help you achieve your ultimate planning goals.
15
MONETIZING ART
A number of options are available to you in planning to monetize part or all of your art
collection, using the art as collateral for a loan or sale at public or private auctions, by
private sales or at art galleries.
LEVERAGING VALUE FROM ART – USING ART AS COLLATERAL
Obtaining credit with art as collateral may be a convenient way to leverage an illiquid
asset to fulfill a borrowing need while still being able to keep possession of the art. The
purpose of the loan itself can range from a multitude of business purposes to more
personal trust and estate and wealth diversification reasons. Lines of credit and term
loans can be structured with the art as collateral and there is typically a high degree of
customization associated with these loans. A rule of thumb loan-to-value is 50% and you
should be prepared to demonstrate the ability to comfortably repay the loans without
the need to sell the art. Loans of this nature are typically dedicated to borrowers who are
art collectors, rather than investors.
SELLING ART
In considering sale options, it is important for you to realize that the art market is
comprised of a number of unique submarkets defined by artists and genres, which
operate relatively independently. The upside of this is that a motivated seller will usually
be able to locate a willing buyer. The downside, however, is that many submarkets lack
transparency, valuations are highly subjective and the price obtainable for a particular
work depends in part on the collector or investor’s taste or aesthetic. If you wish to sell
some or all of your art collection, there are important considerations and steps to follow
to avoid jeopardizing the transaction.
First, potential sellers of art must understand the tax consequences of selling works of
art. If the sale is of long-term capital gain artwork, any gain realized on the sale of the art
will be subject to the 28% capital gain Federal income tax rate.37
Second, if you choose to sell your works at a major auction house, you will be subject to
a variety of selling costs and fees, which will be deducted from the final sale price. The
fees can include commissions, insurance coverage, authentication changes, as well as
the costs associated with marketing the works as part of a larger sale.
In deciding to sell works of art, there are important steps that you, as either the seller or
the buyer, should follow to properly execute the transfer. For example, completing a final
bill of sale, transferring title, changing applicable insurance policies and arranging for
physically transferring the art can all be part of the sale process. You should work with
qualified art advisors, who can assist in determining the appropriate sale venue in order
to maximize sale proceeds and fulfill your intentions.
Wealth Planning with Art
LEASE BACK ARRANGEMENTS
Some collectors may wish to transfer works of art to children or grandchildren, but they
hesitate to transfer the art outright to subsequent generations. The hesitation may be
out of concern that the potential recipients are not able to properly care for the art, or
the hesitation may be due to a desire to still enjoy and display the art. For collectors
facing this dilemma, a potential solution may be to transfer the art to an irrevocable trust
for the benefit of children or grandchildren, and then lease the art back from the trust.
The basic structure of the lease-back arrangement can be rather straightforward. The
collector transfers art to an irrevocable trust. The trust beneficiaries may be family
members, such as children or grandchildren, or friends and other loved ones. The
collector executes a lease agreement with the trustees to lease the art for the fair market
rental value, as determined by an independent, qualified appraiser. The collector
makes fair market value lease payments to the trust, which can be used for distributions
to beneficiaries per the terms of the trust, or for necessary expenses (insurance, tax
payments, etc.). The trust can be structured so that the collector is responsible for
paying the trust’s taxes, thereby allowing the income generated by the leased art to be
used for the benefit of named trust beneficiaries. This technique has many potential
benefits, including:
• Removing the value of the art from a collector’s estate (and any subsequent
appreciation);
• Ensuring the art is safeguarded for future generations;
• Generating a rental income stream to the trust to help maintain the art and benefit
future generations; and
• Allowing the art to remain in the home of the grantor to enjoy and display.
In order to take advantage of this planning technique, it is critically important that
collectors work with experienced attorneys and qualified appraisers. There are many
pitfalls, such as failing to pay fair market value for the leased art, which can jeopardize
the transaction. Having a team of advisors to help structure the transaction can avoid
these pitfalls.
17
Auction – Auction is a transparent process that exposes the art work to a bidding
audience. The location of the market place is critical to a successful sale at the auction.
Works sold at auction receive a free “auction estimate,” which is a range of values
provided to give the seller a sense of the value for the art object. Auction estimates can
be an important marketing tool in presenting a work at auction. Most works also carry a
“reserve price,” which is the confidential minimum price below which the work will not be
sold. The reserve price is known only to the seller and auction house.
An appropriate time to start considering an auction is three to four months ahead of
the scheduled sale season. During that period of time you should have the artwork
inspected by a qualified expert, obtain auction estimates, engage the auction house,
pack and ship the artwork to the auction house, catalogue the artwork, create marketing
materials and schedule a pre-sale exhibition a week before the sale.38
Should you, as the seller, need funds in advance of the sale, there are a number of
options available for raising that cash. The auction house may advance some of the
projected sale proceeds to you. The auction house may guarantee a sale, offering you a
minimum price regardless of the outcome of the sale. Or, you may obtain a loan from a
financial institution secured by the artwork.39
In order to protect the confidentiality of the parties to an auction sale, auction houses
will sometimes engage in a private treaty sale, and the information regarding the sale is
not made publically available.
Private or Gallery Sale – In some cases, a private sale will be preferable, either because
the parties would prefer to remain anonymous, they want to avoid publicity, the timing
of the auction cycle does not match their required timeline or the artist’s work has yet to
reach high prices at auction and can realize stronger prices through private transactions.
The latter example is particularly relevant for an artist with a strong regional following.
Most of the data on art values comes from public auctions. Gallery sales and private
auction sales are unreported. Therefore, it is very difficult to obtain information on these
transactions. Whether you are a buyer or a seller, parties to an art transaction are well
advised to conduct their due diligence and to carefully negotiate purchase and sale
agreements of artwork, with advice of counsel, to protect themselves.
Movement of Art – Each country has its own rules for the movement of artwork
either into or out of the country. There are taxes to be considered, as well as customs
duties, treaties, and international agreements on transfer of cultural goods to observe.
Freeports, which are warehouses holding art in certain tax havens like Switzerland,
have the potential to become important hubs for collectors and their advisors. With the
increasingly global nature of the art market the demand for storage facilities and
duty-free zones is likely to increase.40
Wealth Planning with Art
INHERENT MARKET RISKS MAY FRUSTRATE MONETIZATION
Approaching the task of monetizing an art collection is made more challenging by the
fact that there is no fundamental pricing model for art. Aside from the psychic pleasure
art produces, there is no clear income stream that flows from it. Each piece of artwork
is unique, and even different measuring standards for the same artist can depend on
the medium or at what point in the artist’s career the work was created. The lack of
a fundamental pricing model for art means that art is subject to fads, fashions and
potential bubbles. Is the current intense interest in contemporary art, for instance, one of
those market bubbles? Without an established pricing model, it is difficult to answer this
question.41 Working in collaboration with expert and independent appraisers, reputable
auction houses, dealers, art advisors, galleries, insurers and wealth advisors, you can
better identify the goals for your art assets and be better prepared to navigate the
nuanced art market to achieve your goals.
EXCHANGING ART
For the art investor who is sensitive to the tax impact on their art transactions, a
tax-deferred exchange may be a strategy to consider. Code § 1031 provides for the
tax-deferred exchange of like-kind property held for investment. Tax-deferred
exchanges of art may be of particular interest given the higher 28% tax rate on the
sale or exchange of collectibles, including art, as compared to 20% tax rate for
long-term capital gain property generally.
A Code § 1031 exchange may be accomplished by a simple simultaneous “swap”
between two parties. More often the exchange is more complex, involving an
intermediary to broker a gap in time in the transaction. In a forward exchange, you sell
your relinquished asset to a second investor and the intermediary holds your cash.
Within 45 days of the sale of the relinquished asset, you identify the replacement
property in writing and you complete the purchase within 180 days of the initial sale.
Be aware that the IRS admonishes its examiners to be on the alert for Code § 1031
exchange issues involving art exchanges. Code § 1031 exchange treatment is not
available for inventory42 or for exchanges of property differing materially either in kind
or extent.43 The Service has stated an unofficial view that:
“The owner of a work of art enjoys different legal entitlement that the owner of another
work of art. Each owner has a pecuniary interest in and is entitled to sell a unique piece
of property. Therefore, trading artwork for other artwork is an exchange of materially
different property.”44
19
TAXING ART
Artist and Donee
of Artist
Hobbyist
Investor
Dealer
Business Collector
TYPE OF PROPERTY
Ordinary
income property
Generally,
capital asset
Generally,
capital asset
Ordinary income
property (inventory)
Generally,
capital asset
SALE
Ordinary income
Capital gain, but
no capital loss
Capital gain or
capital loss
Ordinary income
Capital gain
or capital loss
CODE § 1031
EXCHANGE
Not available
for artist or donee
of artist
Not available
for hobbyist
collectors
Conditions for
exchange treatment
must be satisfied
Not available
for inventory
Conditions
for exchange
treatment must
be satisfied
CHARITABLE
CONTRIBUTION
Deduction limited
to basis of property
contributed
Deduction for the
fair market value of
property contributed
Rules vary based
on organizational
structure
Deduction limited to
basis of property
contributed
Rules vary based
on organizational
structure
When assessing whether Code § 1031 like-kind exchange treatment may be available for
a disposition of art, there are a number of specific requirements to satisfy:
• The original property must be held for investment.
• The acquired replacement property must be of a like-kind.
• The replacement property must be identified within 45 days after the original
property is sold.
• The replacement property must be received within the earlier of 180 days of the initial
sale and the due date of the tax return (without extensions) for the tax year – this is
what is known as the “replacement period.”
First and foremost, in order to qualify for like-kind exchange treatment, the art must
be held for investment and, at the time of the exchange, you must intend to hold the
replacement art for investment. This is a question of fact and there is no authoritative
guidance to rely upon.45 Personal use of more than a limited degree will preclude
like-kind exchange treatment.
Wealth Planning with Art
As to the qualitative like-kind question, we have very little guidance in the art realm.
For tangible personal property generally, the like-kind standard has traditionally
been interpreted more narrowly than for real property exchanges. As to antiques, we
know – because the IRS has provided examples in regulations – that an exchange
of a particular model of antique car for another model of antique car is considered
a like-kind exchange, but the exchange of an antique car for antique furniture is not
considered like-kind. As to coins, bullion-type coins and numismatic-type coins are not
like-kind, nor are silver bullion and gold bullion.46
Recent U.S. budgets have proposed to limit tax-deferred exchanges under Code § 1031
to $1 million per-investor per-year. Repeal has been proposed in recent years by both
Senate and House committees. Where these various proposals will lead is yet to be
determined. This is yet one more complex area requiring careful navigation.
CONCLUSION
We conclude where we began: in appreciation for art and for artists, and with a further
appreciation for the many associated considerations to be contemplated by those with
an affinity for art, whether for passion or for profit, who are incorporating art into their
overall wealth planning and management.
FOR MORE INFORMATION
As a premier financial firm, Northern Trust specializes in life-driven wealth management
backed by robust technology and a strong fiduciary heritage. For more than 125 years
we have remained true to the same key principles – service, expertise and integrity – that
continue to guide us today. Our Wealth Planning Advisory Services team leverages our
collective experience to provide financial planning, family education and governance,
philanthropic advisory services, business owner services, tax strategy and wealth transfer
services to our clients. It is our privilege to put our expertise and resources to work for you.
If you would like to learn more, contact a Northern Trust professional at a location near
you or visit us at northerntrust.com.
21
1
2
r. Clare McAndrew, TEFAF Art Market Report 2016 (2016).
D
Clare McAndrew, Fine Art and High Finance: Expert Advice on the Economics of Ownership
loc. 393 (2010).
3
Press Release, artnet, artnet Releases Six-Month Auction Results
(July 22, 2015) (on file with author).
4
Dr. Clare McAndrew, TEFAF Maastricht, The TEFAF Art Market Report 2015 (2015).
5
Press Release, artnet, artnet Releases Six-Month Auction Results (July 22, 2015)
(on file with author).
6
Id.
7The ARTnews 200 Top Collectors: 25th Anniversary Edition, ARTnews,
(Summer 2015).
8
Katya Kazakina, Global Art Sales Hit Record $54 Billion, Led by U.S.
Buyers, Bloomberg Business, Mar. 11, 2015, http://bloom.bg/1GF03bm
(last visited Aug. 12, 2015).
9Dr. Clare McAndrew, TEFAF Maastricht, The Global Art Market, with a focus on the US and China
49 (2014); See also Alexander Forbes, What is Behind the Art Investment Boom?, artnet news,
Sept. 26, 2014.
10 Id.
11 Id.
12The Am. Coll. of Trust and Estate Counsel, What Your Client Really Cares About: Planning for
and dealing with their treasured art and collectibles 5 (2015).
13 Id. at 7.
14 Id. at 13.
15Clare McAndrew, Fine Art and High Finance: Expert Advice on the Economics of Ownership
loc.1306 (2010) (ebook).
16The Am. Coll. of Trust and Estate Counsel, What Your Client Really Cares About: Planning for
and dealing with their treasured art and collectibles 12 (2015).
17nemona Hartocollis, Despite Court Ruling, Christie’s Pulls Painting From
Auction, N.Y. Times, Nov. 8, 2006.
18 Treas. Reg. §§ 1.170A-1(c)(2), 20.2031-6, 25.2512-1.
19 Treas. Reg. § 1.170A-1(c)(1).
20 Treas. Reg. § 25.2512-1.
21 Commissioner of Internal Revenue, Art Advisory Panel, Ann. Summary Rep. for Fiscal Year
2015 (2016).
22 Treas. Reg. § 1.170A-13(c).
23 Treas. Reg. § 1.170A-13(c)(5)(i).
24 Treas. Reg. § 1.170A-13(c)(5)(iv)(F).
25 IRC § 170(f)(11)(E)(ii)-(iii).
26 Treas. Reg. § 1.170A-13(c)(3).
27 IRC § 6662(e), (h).
28 Estate of O’Keeffe v. Commissioner, T.C. Memo. 1992-210.
29 Id.
30 See, e.g., Estate of Elkins v. Commissioner, 767 F. 3d 443 (5th Cir. 2014).
31
32
Treas. Reg. § 20.2031-6(b).
Treas. Reg. § 301.6501-1(f)(3).
Wealth Planning with Art
33 Rev. Proc. 96-15.
34 Id.
35 IRS Publication 526.
36 IRC § 170(e)(1)(A); Treas. Reg. §§ 1.170A-8(d)(3), 1.170A-4(b)(2)
37 IRC § 1(h)(4).
38The Am. Coll. of Trust and Estate Counsel, What Your Client Really Cares About: Planning for
and dealing with their treasured art and collectibles 17 (2015).
39 Id.
40Dr. Clare McAndrew, TEFAF Maastricht, The Global Art Market, with a focus on the US and China
71 (2014).
41 Nouriel Unplugged, EconoMonitor.com, 2/11/2015.
42IRC § 1031(a)(2)(A) (exception for stock in trade held primarily for resale).
43Treas. Reg. § 1.001-1(a) (gain or loss is realized when property is
exchanged for other property differing materially in either kind or extent). See also, Cottage
Savings Association v. Commissioner, 499 U.S. 554 (1991).
44 Internal Revenue Service, Artists and Art Galleries Audit Technique Guide, 2012 ARD 03303
(Feb. 15, 2012). This document is not an official
pronouncement of the law and cannot be used, cited, or relied upon as such.
45 Northern Trust, Art as an Investment, Wealth Magazine (2013).
46 Rev. Rul. 79-143 (coins); Rev. Rul. 82-166 (bouillon).
LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and
should not be treated as legal advice, investment advice or tax advice. Readers,
including professionals, should under no circumstances rely upon this information as a
substitute for their owsn research or for obtaining specific legal or tax advice from their
own counsel.
23
northerntrust.com
Q157100 (9/16)