You Can’t Take It With You
October 2007
THROUGH 32 YEARS of marriage, Norma Canelas-Roth and William Roth have amassed an art collection rich in textiles, beadwork and headdresses from Africa, Asia and the South Pacific. They own silk robes from the Qing dynasty. Their trove of more than 1,500 headdresses includes one festooned with feathers from the cassowary and other exotic birds. Another contains the entire mane of a lion.The collection—an estimated 15,000 pieces in all—reflects more than three decades of frenzied, passionate pursuit. Yet for most of that time the Roths (she is 64, he is 70) gave little thought to how they wanted their art to be dispersed when they die. And they’re not alone. Many art lovers never consider their million-dollar-plus collections in their estate plans. Big mistake. If you’ve spent a lifetime assembling a museum-worthy collection, you’ll need a strategic plan for its orderly succession. Says Peggy Hollander, the founder of The Succession Group in Coral Gables, Florida, "Recognizing its value and planning for it is incumbent upon the art collector."
Of course, you can’t recognize the value of art without first confirming its authenticity. Karl
Schweizer, the head of art banking for UBS, the Swiss financial conglomerate, believes the art world too often falls short on accountability. Before buying any work of art, Schweizer says, a collector should check with the Art Loss Register, a global clearinghouse of legitimately owned as well as stolen and forged art. "If everybody speaks about art as an investment, they should first do their homework to know what they buy, to know what they have, before you discuss anything else," says Schweizer. "A piece that does not have a proper background is not sellable."
Once you can account for your art’s provenance, you’re ready to plot its eventual distribution in your estate plan. You’ll need to assemble a team of trusted advisors—a lawyer, accountant and financial planner, for starters—who can help you dispose of your art in a way that is meaningful and financially sound for you and your heirs. Michael Mendelsohn, founder of Briddge Art Strategies Ltd., an art succession planning firm in Purchase, New York, says that a piece of art mishandled in the estate planning process could lose as much as 70 percent of its value—through a collector’s failure to mitigate estate taxes, say, or a poorly conceived sale at auction. "The reason that happens is a lack of planning," says Mendelsohn, who recently published Life is Short, Art is Long (Wealth Management Press, 2006) to guide collectors in long-term thinking about their art.
Collectors have three basic options: Leave your art with your family, donate it to a museum or other charity or sell it outright. Each choice is rife with legal and tax implications that will require help from your advisory team.
All in the Family. "You don’t want to create a family art war because of bad planning," Mendelsohn says. Certainly, no option has more potential to create domestic friction than keeping art in the family. Many collectors are surprised to learn that the art they hold so dear holds no real appeal for their offspring. That’s why Hollander stresses the importance of open communication between advisors and collectors and between collectors and their families.
In addition, Mendelsohn warns against the "empty-hook syndrome." This occurs when you assume that your children will simply remove the paintings on your wall and hang them on theirs. It’s never a good idea to leave even a single painting to your children without telling anyone. When your children later want to sell the painting, they’ll be asked to present a record of its provenance. Without that paper trail, the work’s value will be diminished. And if your children eventually do sell the painting, the Internal Revenue Service won’t be happy to learn that they’ve generated income from an asset that your estate never accounted for.
If you plan to leave art to your children, you and they would be wise to sit down with your advisors and discuss the logistics. Estate Taxes. You must consider the tax bill your children might inherit. Unless the collector’s will stipulates otherwise, the beneficiary is responsible for paying estate taxes on inherited property. Your advisors can show you how to ease the burden on heirs created by estate taxes (the federal rate is 45 percent, and some states impose their own estate taxes) that could stretch into six figures. "If you’re not leaving your property to either your spouse or charity," says Susan Porter, a managing director with U.S. Trust, Bank of America Private Wealth Management, "the most significant beneficiary of your estate will be Uncle Sam." While we’re on the subject of taxes: If your children later decide to sell your works, they will be liable for the 28 percent federal capital gains tax on fine art—nearly double that of most other assets. In some cases, a will may specify that certain assets be bequeathed. Those assets that are not specifically accounted for (known as the "residue") can then be used to pay estate taxes as well as the cost of executing the will.
Another mechanism is an irrevocable life insurance trust, whose proceeds, when you die, could be used to cover estate taxes.
Prepare for an Audit. When a tax return that includes artwork valued at $20,000 or more is selected for audit, the taxpayer’s case is referred to the Art Advisory Panel, an arm of the Internal Revenue Service that reviews the art to determine whether the works in question have been assigned the proper value.
Living taxpayers and estate executors have different goals when it comes to valuing their art. To help members of the panel maintain objectivity when assessing an object, they are not told whether the object they’re valuing is from an estate or a charitable donation.
Taxpayers who find their cases called before the 20-member panel need to provide detailed documentation to win their case. It’s not always easy. In 2006 the panel reviewed 124 taxpayer cases involving more than 1,600 items with a combined taxpayer valuation of more than $219 million. Of those cases, the panel upheld only 38 percent of valuations submitted by taxpayers’ appraisers. Among the other items, the panel recommended adjustments that reduced charitable contribution claims by a total of 57 percent (or nearly $1.9 million) and increased estate and gift appraisals by a total of 95 percent ($117.7 million).
"It all boils down to documentation," says IRS spokesman David Stewart, "and that’s going to be true for any taxpayer for any reason." Karen Carolan, the chief of Art Appraisal Services for the IRS, says any art valued at more than $3,000 needs to be appraised. Carolan says the appraisal should contain: the name of the artist or culture; a description of the work; the work’s provenance; the appraisal date (and whether the appraisal was done in person); and a description of special circumstances that could affect the work’s value. For higher-value pieces, the appraisal should include an explanation of how the appraiser arrived at the value as well as the comparables (results from recent sales of similar works with an explanation of how they compare).
Carolan says it’s imperative that the taxpayer or executor provide high-quality photographic images of the artwork in question. These may include: 4-by-5-inch transparencies; 8-by-10-inch clear color photographs of professional quality printed on photographic paper or high-resolution color digital images labeled with descriptive information and submitted on CD. For a more detailed list of what is and is not acceptable regarding formats for images submitted to the panel, visit irs.gov, type in "art advisory panel" and click on "Art Appraisal Services."
Taxpayers may also request a "fast-track" appraisal from the IRS, to be done before the tax return is filed. To qualify for the fast-track procedure, the taxpayer’s art collection must contain at least one piece worth $50,000 or more. This option costs $2,500 for the first three objects and $250 for each additional object. A taxpayer who disagrees with the panel’s findings may request a reconsideration but must provide new information pertaining to the value of the work in question.
Insurance. Once the collector has died, the estate’s executor is responsible for providing insurance on the artwork until the heir takes possession. Generally speaking, unless the collector’s will dictates otherwise, once a beneficiary takes possession of a piece of art, he or she also assumes responsibility for its care. That may include the costs of insurance, packing and shipping, among others. "One of the most critical steps for the executor is to make certain you have adequate security and insurance coverage," Porter says.
A Legacy of Giving. Gifts from collectors who wished to leave an artistic legacy fill museums across America. If you want to donate some or all of your collection, your advisors can guide you through a variety of gifting mechanisms, including trusts and foundations. They might advise you
to give away some of your art during your lifetime for the income tax benefit (the
value of charitable gifts of art can be deducted from a collector’s gross annual income, thus reducing his or her taxable income).
To qualify for tax benefits, a gift of art must pass the "related-use" test—the gift must be related to the beneficiary’s primary function. Philip Temple, an attorney in White Plains, New York, who assists in art succession planning, says collectors should also be apprised of recent changes in federal law regarding partial-gift taxes (see Art&Antiques, November 2006) and appraisals (see Art&Antiques, September 2007).
You might envision your favorite museum putting your gift on permanent display. But if the museum decides to sell it instead, your gift may not pass the related-use test, in which case you’d lose out not only on your legacy, but on the potential tax benefits of your gift. Doug Moore, the managing director and head of estate and charitable planning for Citi Trust in New York, says collectors typically assume that a museum will welcome their gift with open arms. "That’s not correct," Moore says. "Museums will often say no thank you."
On the Block. Mendelsohn often advises clients to donate or sell the "bottom third" of their collections while they’re still alive. Most likely, he says, the collector assembled these pieces early on, before his or her eye was finely tuned. Those sales can help reduce the value of your estate, and thus your estate tax liability.
If you’re charitably inclined, you can also dispose of your artwork by placing it in a charitable remainder trust, which enables you to generate income on the sale of the art during your lifetime, defer capital gains taxes on those sales and eventually leave the assets in the trust (cash or marketable securities) to charity. Under the rules of a charitable remainder trust, the immediate income tax charitable deduction is limited, because the art, which is intended to be sold and not displayed, is considered to be unrelated to the trust’s purpose. (In any case, the deduction cannot be taken until the art is sold.)
Clearly, Moore says, collectors establish charitable remainder trusts primarily to defer capital gains taxes; any income tax benefits are secondary.
As for the Roths, while they’ve begun to plan for their collection’s future, they still have much work to do. Teaming with Mendelsohn, they’ve set up a charitable remainder trust. They plan to will certain pieces to their son Michael, 29, the youngest of their three children and the only
one who shares their artistic interests. "The collection is too big for one person," Norma says.
The Roths plan to leave most of their collection to museums. But which ones? And who’ll get what? Norma says a likely beneficiary will be the Orlando Museum of Art, to which she and her husband have donated contemporary, pre-Columbian and African art over the past 25 years. William also wants to leave something to the Michael C. Carlos Museum at Emory University in Atlanta, his alma mater.
"We haven’t decided on any of it yet," Norma says, though she does confess one wish: "It would be nice if the whole headdress collection could stay together."
Christopher Hann writes about culture and business for publications including The New York Times, Executive Traveler and Leader’s Edge.