Blockage

I have been digging out of the 24" inches or so of snow here in the Virginia suburbs of Washington DC.   We did not lose power, cars are dug out, so hope to get back to normal routines tomorrow.

Fellow appraiser Cindy Charleston Rosenberg, ISA CAPP sent me this new article published by Ronald Spencer in his Winter 2015/2016 Art Law Journal. It contains a very interesting article on Blockage, with references to numerous court cases.  Well worth reading for the professional appraiser.

Here is a partial post, follow the below source link for the full artilce.

This essay addresses valuing art by a single artist for estate tax purposes. The difficulty is that the art will likely be sold years into the future because the market will not absorb the bulk of the art by only one artist anytime soon after the date-of death valuation date. So the issue is to determine how much art could be sold, years and years (most likely) into the future, and at what price. Conceptually, the art would be sold by the estate to an investor or consortium of investors for investment and ultimate resale. Its value is the amount the buyer/investor would pay to the estate for his investment in the artist’s art
inventory. –– RDS
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RONALD D. SPENCER is Chairman of the Art Law Practice at the New York law firm of Carter Ledyard & Milburn LLP. He is expert in the legal aspects of art authentication issues and has written and edited, The Expert Versus the Object: Judging Fakes and False Attributions in the Visual Arts, (Oxford University Press, 2004).
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Blockage Discounts in the Courts
Valuations of art for estate and gift tax purposes (as well as for divorce and sale) present difficult issues when the art consists of many works by only one artist, chiefly because the art market can only absorb a limited number of works, yet the appraisal must decide value as of a certain date – in an estate, the owner’s date of death. Consequently, this requires the valuation to determine the worth of a stream of income from art sales, sometimes in the rather distant future. Since it is quite clear that it would be imprudent to sell simultaneously and immediately a large number of works by the same artist, three United States Tax Court cases have accepted the
concept of a “blockage discount”.

Unhappily, these three Tax Court cases involving the art in the estates of David Smith, and Georgia O’Keeffe, and gifts of Alexander Calder art, while accepting the concept of “blockage” to discount the value of the art, have applied the concept in a way to greatly limit the discount and so produce art valuations (that is, a determination of what a buyer would pay) much in excess of real-world values.

Who Is the Hypothetical

Buyer From the Estate: a Large Number Of Retail Buyers or a Single Bulk Purchaser?
In 1972, the Tax Court first took up the issue of a “blockage discount” for the value of art for estate tax purposes.1

The artist, David Smith, died in an automobile accident, May 23, 1965, owning 425 pieces of metal sculpture created during various periods of his life beginning in 1937.

In valuing the art for estate tax purposes, the Smith executors first computed the price of each piece if sold individually at retail at the time of Smith’s death, the total being $4,284,000. The executors then discounted this figure by 75% on the theory that these works could only be sold at the date of death to a bulk purchaser for resale, and then reduced this figure by one-third to cover the sales commissions which would be owed to Smith’s gallery, Marlborough. The resulting figure of $714,000 was reported as the date of death value of the 425 sculptures. The Smith estate argued that, if all 425 sculptures were offered for sale at the date of death, the purchaser could only be a person or syndicate acquiring the bulk of the sculptures for future resale, that such a person would be required to make a large cash investment which could be recouped with an acceptable profit only over a ten-year period of time; and that such a person would only pay 25 percent of the separate one-at-time value, which, after subtracting selling Marlborough commissions of one-third resulted in a value of $714,000.

The Smith court said that the 75 percent discount which the estate had applied to the one-at-time values was “too high”. On the other hand, “We think that, at the very least, each willing buyer in the retail art market would take into account the price he would be willing to pay for any given item, the fact that 424 other items were being offered for sale at the same time. The impact of such simultaneous availability of an extremely large number of items of the same general category is a significant circumstance which should be taken into account.”2

The Smith Estate argued that any value must be reduced by one-third to take account of commissions to which Marlborough Gallery was contractually entitled for its selling efforts. But the Tax Court said that the date of death value is what the estate would receive from a hypothetical sale, that is, “what a purchaser from the estate would pay.” (The Court clearly is thinking only of a retail sale to the ultimate buyer.) Accordingly, the Smith court held that the fair market value at the date of death of the Smith sculpture was $2,700,000, equal to a 37% discount from the hypothetical single-piece total price of $4,284,000.

The Smith Court states, what is no doubt true, namely, that a willing buyer in the retail art market “would take into account the price he would be willing to pay for any given item, the fact that 424 other items were being offered for sale at the same time …”. No doubt true, but not at all helpful in determining the price a bulk buyer would be willing to pay for all 425 sculptures. In effect, the Smith Court is arriving at a valuation of all the estate art by assuming a non-existent retail market, at the date of death, for each and every sculpture. The real market is a buyer or a syndicate of buyers who, in turn, would decide their purchase price from the estate by a calculation of their likely future sales (and cost of selling commissions and expenses) in both the dealer and the retail markets.

Instead of trying to determine what each retail buyer would pay for given a sculpture, the Smith Court should have determined what a hypothetical estate buyer would have paid, since an estate bulk buyer would necessarily hav made his own calculation for future retail (and wholesale) sales. The point becomes more clear, if one thinks of the sale by the Smith estate of the art inventory of David Smith’s “art business”. Accepted procedures for selling a business owned by an estate, clearly suggest that the estate executors would not seek to sell inventory into retail market. Rather, the executors would seek out a bulk inventory buyer interested in investment and future resale in
retail and wholesale markets, who would also consider his selling expenses.

O’Keeffe (Wrongly) Decides That Smith Was Correct. That Is, Value at Date of Death Is What the Retail Buyer Would Pay

Twenty years after Smith, in 1992, the Tax Court3 again took up the issue of a blockage discount for the art of Georgia O’Keeffe in the following words:

The O’Keeffe estate employed Eugene Victor Thaw (Thaw) to appraise O’Keeffe’s works in the estate. It was Thaw’s opinion that the appropriate blockage discount that should be allowed for O’Keeffe’s works in the estate on the date of death is 75 percent.

Thaw’s opinion was based
on the understanding and assumption that all of the works in the estate would be sold to a single buyer as a bulk purchase, which would require a syndicate of investors. The hypothetical buyer would have to hold the works for many years and, in determining the price to be paid, would take into account interest, selling costs, promotion, maintenance costs, and carrying charges. Thaw also based his opinion on the assumption that a buyer would consider “fluctuations from the very high market plateau for O’Keeffe’s in 1986”, although he would have advised a potential buyer that prices of works by O’Keeffe, on average, were unlikely to go down. 

Source: Spencer's Art Law Journal