Whether you’re an artist whose work is selling at increasingly high rates, or a collector whose prized lot is becoming increasingly valuable, taking steps towards thoughtful estate planning can be the difference between a windfall and a total loss. And while no one likes to plan for the inevitable, your family and benefactors will greatly appreciate that you took cautionary steps to increase their bottom line come judgment day.
Of course, the landscape is different depending on which side of the table you’re sitting on: if you’re an artist looking to reduce your tax bill upon your death, there’s a variety of steps you can take to reduce your footprint while you’re still alive. And as a collector, you’ll want to be certain that you’re selling your art at a time when its fair market value is especially high or making plans to hang on to it and have its sale administered by someone who knows to wait until the perfect moment.
For both artists and collectors, determining the fair market value of artworks remains a pivotal aspect of estate planning, but the appropriate methods for determining such a value remain complex. There are various landmark cases that are helping legal professionals better determine the fair market value of artworks, one of which we’ll discuss here, along with various useful tips for estate planning for artists and collectors alike.
Estate Planning for Artists
If you’re becoming more and more successful as an artist and accumulating increasing amounts of your own art, then estate planning is essential to ensure that you’re not unnecessarily giving all of your money to Uncle Sam. But what’s the measure of success according to the IRS? If your entire estate, with art included, is valued at over $5,120,000, then you could be held to some pretty steep taxes upon your death. If your estate is currently worth that much, then there are a few steps you can take within your lifetime to significantly reduce the amount you could owe to the IRS upon your passing.
One of the best thing artists can do to minimize estate taxes is to give non-taxable gifts in their lifetime. According to the IRS, gifts are non-taxable so long as the total amounts to less than $13,000 per year to any one entity. That means artists can give a maximum of $13,000 to various individuals and organizations every year – their friends, their favorite museums, or their favorite charities, in order to minimize the value of the collection to be calculated at the time of your death.
It may seem counterintuitive to give away your fortune while you’re still alive, but if properly planned, you’ll only wind up saving yourself a ton of money in the end. In order to keep this legit, supply the IRS with full documentation as to dates, recipients, and amounts through proper documentation – and don’t overlook the importance of legal counsel in getting through the process.
Estate Planning for Collectors
Many collectors have spent years amassing a collection they’re proud of, getting to know the market, the major art world players, and perhaps even successfully gambling on an up-and-comer that wound up getting (and paying off) big. So it’s understandable why most collectors don’t want to see the collection go up for auction upon their death, and the best way to ensure that this happens is to avoid doing any estate planning during the collector’s lifetime.
The wise collector will opt for a careful estate plan so that their collection will have a solid future once they’re no longer around to care for it. The first step would be to gauge the collector’s heirs’ interest in acquiring and maintaining the collection. If they’re willing to take on the collection, then a collector can have an attorney draw a revocable family trust and name their heirs as beneficiaries, so that they can avoid probate proceedings and any estate tax issues that may come up. If the total value of the collection is less than the $10.4 million a lifetime gift-tax exemption, then the heirs won’t owe any estate tax on the art, but of course, would be held to capital gains taxes should they choose to sell the art at a future date. However, the taxes would only be collected based on the value of the work at the time of the collector’s death – meaning that if the heirs chose to sell at a time when the collection is valued considerably higher, they’d only pay the taxes on the value of the work at the time they were inherited.
Even if a collector’s heirs don’t wish to keep the collection, having the artworks in a revocable family trust gives the collector control over how the work is sold. The collector can make arrangements, for example, that state that the collection must be sold only to one buyer. And just like artists have the option of gifting works throughout their lifetime, collectors have this option too: Donating artwork during a collector’s lifetime entitles that collector to an up to 30% income tax reduction depending on the value of the artwork at the time it was donated. There’s also the option of fractional donations, in which a collector can give a percentage share of a painting to a museum, and the museum would have that painting on loan for that percentage of the time. Meaning that if a collector gave 10% share of a $100,000 painting to a museum, they would be entitled to a $10,000 income tax deduction and the museum could keep the painting for 10% of that year.
Now Comes the Hard Part: Estimating Fair Market Value
While making a plan for your collection is certainly important, the process becomes tricky when it’s time to assign a fair market value to the work. The complexities and fluctuations of the art market, coupled with what’s going on in the artist’s public life, can greatly influence the market value of an artwork, which ultimately affects the amount of taxes you’ll pay as a collector or artist on the estate of your collection.
According to the IRS, fair market value is defined as
“the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”
Determining the fair market value of an artwork can be especially complex because there are so many relevant facts – and relevant case law – setting a precedent for how an artwork should be valued. And in an estate situation, in which the original owner has passed away, assessing an artwork’s value can be hotly contested since it’s tied to the value at the time of the owner’s death.
A professional appraiser will typically look to various factors, such as the value on the date of death, the appreciation over time, and the best comparable values of works sold. And the Tax Court will typically look to case law to determine how they’ll assess the current taxable value of artworks, but the analysis is constantly changing. Just take a look at a recent seminal case, Estate of Newberger v. Commissioner, T.C. Memo. 2015-246, which demonstrated the court’s application to the market when assessing the fair market value of the decedent’s collection.
In that case, the court considered three factors: the state of the market, other comparable sales, and the work’s appreciation. While the market was depressed at the time of the decedent’s death, and the work had been assessed at the time of the owner’s death to be valued at $5 million. When it sold for $12 million, the estate tried to report that its value was only the $5 million estimated at the time of the owner’s death, to which the court said, “not so fast.” Taking into account the sales price, the IRS adjusted the value to $10 million, which reflects both the depressed market and the adjustment for the sales price.
But then conversely, on another work in question the court used a comparable sale to refute the IRS’s contention that a Motherwell painting, which had sold for $1.5 million, was valued as such, and not the $800,000 the estate contended. In fact, the estate was right, since the comparable sale being used reflected the value of the artwork at the time of the sale was in 2008 when the market was low. Since the owner died in that same year, the court concluded that the fair market value of the Motherwell was $800,000.
Whether you’re an artist or collector, assessing fair market value in estate planning can be helpful, because it may serve as a guideline for determining when you want to sell: whether you wait until you’re dead, start gifting while you’re alive, or create trusts that teach your heirs how to minimize their taxes, planning for the future will serve you well.
Nicole is a writer and law school graduate with a dedicated focus and passion for the arts, and a particular interest in Latin American art and history. Nicole has extensive experience working with art galleries and museums in Buenos Aires and Miami, and explores cultural landscapes across the Americas through her writing.