Fine Art and Estate Planning

Barron's recently posted an interesting article on collecting fine art and how it may impact estates and estate planning. The article is good as it points out the need for appraisals, but also speaks to the ability of the IRS to use trends and data at the time of an audit to adjust the valuation. One solution the article notes is to get at least two appraisals and valuations for high end art works to minimize bias and to support the valuation.  The IRS also has the added resource of looking at the market and trends after the dead of death and using that information to make adjustments. We as appraisers dont have that option, especially if we are valuing within months of the date of death.

This article also discusses penalties, and I have always been informed should the IRS use data not available to the appraiser, then typically there are not penalties applied. In the example in the Barron's article there are penalties applied, but no real detail on the IRS analysis and rationale other than an expanding and strengthening market.

Barron's reports

Your Jeff Koons could destroy your estate plan and leave your heirs shell-shocked and scrambling to pay bills. That’s because the Internal Revenue Service is rigorously scrutinizing appraisals of artworks above $50,000 and often demanding value adjustments that trigger unexpected and large tax bills, with penalties and interest added on.

Consider what happened to the estate of art collector Bernice Newberger and her Tête de Femme by Pablo Picasso. She died in July 2009, when the art market was still reeling from the recession, and her estate deemed the date-of-death value of the painting to be $5 million, based on a Christie’s appraisal.

In December 2009, the work was put up for auction near the Christie’s estimate, and fetched a shocking $12.9 million. Four years later, in 2013, the IRS revised the date-of-death value to $10 million, noting that postmortem sales should be factored into appraisals. An unexpected $5 million was subject to the 40% estate tax and 20% in penalties.

What are the chances of this happening to your estate? The IRS has an Art Advisory Panel composed of experts such as curators, art professors, and gallery directors, which makes recommendations on works forwarded for review.

From 2011 to 2014, the IRS raised appraisals for estate- and gift-tax returns and lowered those for charitable deductions—both moves resulting in higher tax burdens—on 41% of the total 1,394 appraisals that it reviewed. In 2014, 58 out of the 159 estate appraisals the IRS panel scrutinized were increased from a total of $36.3 million to $66.8 million, an eye-watering 84%.

Penalties are 20% of the amount underpaid, when appraisals are 65% or less of what the IRS thinks they should be. The penalty doubles to 40% if the valuation is 40% or less of the IRS’. Skulduggery on the part of the collector isn’t necessarily at work here.

With an asset like real estate, an appraiser can look at several similar parcels that were sold. “But what if you have a beautiful, one-of-a-kind sculpture?” asks Jack Nuckolls, national technical director of BDO’s U.S. Private Client Services practice. “There is always going to be a range of possible valuations for fine art. So as good as your expert might be, the IRS might disagree.”

But, of course, values also come down, particularly in the shadow of ephemeral collecting fads. Alan Breus, 79, of the Breus Group, a San Jose, Calif., appraisal firm, owns a 1897 original limited-edition poster by Henri de Toulouse-Lautrec.

About five years ago, he says, his mint-condition poster was valued at $75,000, “but now it’s down to $40,000.” The artist “has lost favor.” With this sort of correction in the other direction, meanwhile, it’s hard to get a clawback from the IRS. You’d have to prove a serious mistake was made with the date-of-death valuation to persuade the IRS to lower it, says Diana Wierbicki, an attorney and chair of the art-law practice at Withers Bergman.

So what’s a collector to do? Estates should get two artwork appraisals. Heirs, in turn, should brace themselves for an IRS valuation audit and have a fallback plan for paying unexpected taxes, should the ruling go against them.

There’s not always a happy ending. “We’ve had people say they want to keep the art pieces in the family, but they feel like they have to sell to pay taxes based on a valuation after an audit,” Wierbicki says. “This is a very difficult position for families.”\

Consider the debacle in 2007 involving Robert Rauschenberg’s 1959 mixed-media work Canyon, which features a stuffed bald eagle in the foreground. When the owner of the work, Ileana Sonnabend, created her estate plan, the fair market value was deemed to be zero, because it is illegal to sell bald eagles. But after her death in 2007, the IRS’ Art Advisory Panel came up with a revised value of $65 million and demanded an estate-tax payment of $29 million, plus $11.7 million in penalties and interest.

The estate settled. It donated the work to the Museum of Modern Art in New York for a valuation of zero, which meant the family didn’t have to pay estate taxes and penalties, but it didn’t get any charitable deductions, either.

Still, some smart folks have managed the tax liabilities well for their heirs. Scott Hodes, a Chicago collector, has donated half a dozen pieces—mostly by Christo Vladimirov Javacheff, known for wrapping buildings and landscapes in fabric—to museums during his lifetime.

While Hodes says his primary motivation was “to give great works exposure to the public,” lifetime donations are also less messy.

In fact, taxpayers can apply to the Art Advisory Panel for a statement of value prior to making a gift, so the amount of the charitable deduction isn’t likely to be disputed by the IRS.

In this game, that’s a win.

Source: Barron's