Fine Art and Estate Planning

Fellow appraiser Tony Pernicone, ASA, ISA AM sent me this interesting article from the NY Times on estate planning when fine art is involved. The article gives some good insight into handling high end art collections and estate planning, and various tax consequences of planning and not properly planning. As appraisers, we are not tax advisors, but it is always a good idea to understand the issues involved so you can understand client needs and how an appraisal may fit into the planning process.

The NY Times reports
Art investors are nearly always advised not to invest in art at all, but to collect it. Buy what you like, the conventional wisdom goes, not what you expect to increase in value.

But collectors still must contemplate financial matters, especially related to inheritance, advisers say. It’s essential for them to consider what will happen to their art when they are no longer around to appreciate it.

“As somebody’s art portfolio gets more valuable, it becomes a more significant item in their financial and tax lives,” said Michael Delgass, managing director of Sontag Advisory, a financial planning firm in New York.

Like collecting itself, the planning surrounding it has tangible and intangible aspects, especially involving legacy issues, Mr. Delgass said. There are often unpleasant tax consequences for heirs, who may not be related to the collector and who may not be connoisseurs if they are.

“If you have a very valuable art collection, you may feel responsibility to the public to preserve it,” he said. Meanwhile, “it’s not a given that just because you love it, your kids will love it. Do you want to allocate family resources to hold that forever?”

Specialist advisers exist to handle such issues. They typically focus on tax and legal concerns in estate planning and philanthropy — often across borders. Their expertise in art tends to be a niche within that niche, and they fill a different role from art advisers who steer clients toward certain artists based on their tastes, budget and the state of the market.

The fact that it is difficult to put a price on art can actually work to investors’ favor when planning their estates, advisers say.

“Art is something whose value is very different if you’re going to use it or if you’re going to give it away or lend it to an institution,” said Jordan Waxman, managing partner of HSW Advisors in New York. “It’s an asset that’s not going to solve lifestyle or retirement goals, but it has a distinct advantage as a wealth-transfer tool.”

If you want to pass your Picasso on to the children, it’s better for it to be valued as low as possible. Transfers to heirs, either as gifts during the giver’s lifetime or as part of an estate after death, are taxed at high rates in many countries, though the estate or gift amount usually has to be fairly large before the tax kicks in.

Because Picassos that are similar to yours are not sold that often, a precise value for your work is hard to gauge. The result is that the tax authorities are likely to accept a lowball estimate. But it must come from an independent appraiser, Mr. Waxman said, not your own hopeful imagination, and he noted that rules on valuation and tax treatment vary from country to country.

“You can appraise it for less for gifting purposes because it’s illiquid,” he said. “The market for it has a very wide range — there may not have been comparable sales in recent years — so a $5 million painting may be valued at $3 million.”

Lack of liquidity can help in estate planning, but it can also hurt in significant ways. When you sell shares, the transaction occurs in a public market and is recorded. When you hand the Picasso to your lucky kids, it may create a taxable event that will catch up with the new owners one day.

“You can just take it off the wall and put it on another wall,” Mr. Waxman said. “That transference of property, if it’s not documented, will avoid taxation, but it’s not a legitimate transfer. If it’s not properly transacted, it can lead to major issues down the line.”

One potential issue, Mr. Delgass said, results from having “an illiquid asset that generates a liquid liability.” Say a collector’s heirs inherit $10 million of artwork and the same amount of liquid assets, and they are handed a $10 million estate tax bill.

They can sell the liquid assets, pay the bill and have all their wealth tied up in art, he said, or they can sell the art. But professionals in the small, ruthless, opportunistic art market have a way of sensing desperation and may see the sellers coming; $10 million of art may fetch far less than $10 million in such circumstances.

As the creativity in valuing art suggests, financial planning for collectors often involves changing facts on paper without changing facts on the ground. Advisers often recommend techniques for transferring ownership of art without transferring the art itself.

Collectors can sell art to heirs, in exchange for cash or a promise to pay, or place it in a trust or similar entity, such as a corporation, and then lease it back. Each strategy can convey a tax advantage, though advisers emphasize that the break, if any, depends on a jurisdiction’s legal framework. Without the leasing agreement, they add, such arrangements might not survive scrutiny by the tax authorities.

Trusts or corporations may also help collectors and their heirs avoid tragically bad luck. One feature of many tax codes is that property is subject to estate tax wherever it is situated when the owner dies, said Ruth Raftery, an adviser at Round Table Wealth Management, a New York firm that specializes in cross-border planning issues.

Say you’re Australian and you are bringing a nice, expensive Rothko to Toronto to hang on the wall of your second home there. Now let’s say you die while changing planes in Chicago. The United States will assess estate tax on the value of the Rothko.

Even worse, Ms. Raftery said, because you were not an American citizen or resident during your ill-fated trip through Chicago, only the first $60,000 of the Rothko’s value escapes taxes, instead of the $5.43 million that is exempt for Americans. Should such an event occur, it would represent not just bad luck in Ms. Raftery’s view, but also bad planning.

“If an asset is located in the U.S. but you’re not a U.S. taxpayer, when you die it’s subject to U.S. estate tax because it’s physically here — but those are the rules for people who don’t plan properly,” she said. “You have a trust or corporation own the art so that you, as an individual, don’t have ownership.”

Beyond planning estates and avoiding such gruesome outcomes, advisers counsel collectors on tax-efficient philanthropy. When giving art to an institution, it is best if an appraiser can bump up estimates of valuation to maximize the tax write-off.

Collectors who are eager to be charitable and receive a tax break while maintaining ownership of an artwork, at least for a while, may be able to thread the narrow eye of that needle by lending the work to an institution, advisers say, or remaining a part-owner and donating the rest.

Under American law, a report by BNY Mellon says, a collector can allow the institution to use the work for a certain portion of each year and take a prorated charitable deduction based on its value. But the collector must give the work away entirely within 10 years or at death, whichever comes first, and the tax deduction is based on the value then or when the fractional interest was donated, whichever is lower, with penalties due if deductions are found to have been excessive.

The valuation rules are more stringent than they used to be, so “for many art lovers, it no longer makes sense to gift fractional interests in appreciating works of art,” the report concedes.

These strategies matter only if a valuable collection has been accumulated in the first place. That remains no small feat.

“People make the argument that art is a diversification tool or store of value, but I don’t think you can prove that,” Mr. Delgass said. The idea that art is a sound investment is “part cult, part marketing gimmick. You need to look at this in a hardheaded way.”

The good news is that the quirks of the market provide benefits for collectors that are unavailable to investors in mainstream assets.

“Planning for art is very complicated,” he said. “That’s code for, ‘There are lots of opportunities.”’
Source: The NY Times

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