Holding artworks as part of an estate raises a number of considerations when it comes to transfer, taxation and control. The author of this article goes through how these factors play out in the US.

This news service is looking at the world of art in August – examining areas such as art-based lending, investing in fine art, the philanthropy dimension and issues around collecting. The state of the art world can be a useful barometer for the wider wealth management field. And, as we know, many high net worth and ultra-HNW individuals use some of their assets to buy art; others have bequeathed collections to museums. 

This article examines the estate planning dimension of art, and comes from Matthew Erskine, managing partner, Erskine & Erskine. The editors of this publication are pleased to share these insights and invite responses. As always, the usual editorial disclaimers apply. To enter debate either in the next few weeks or beyond, email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

Lobus recently reported that across three art sales and 62 lots, Sotheby's totaled $364.9 million against a projected low estimate of $262.2 million; Sotheby's November Evening Sales saw a combined $479.6 million across 88 lots sold. Key highlights of the evening included record sales for Francis Bacon, Helen Frankenthaler and Matthew Wong. Upcoming sales include Phillips Evening Sale with a low estimate of $29.4 million across 25 lots, and Christie's with a low estimate of $379.1 million across 82 lots. Although, there are no facts to back up the assumption, the report suggests that the art market is not correlated to the stock market, and in some genres the prices will continue to climb. Whether art is or is not correlated to stock market returns, it is worthwhile to know how art is valued for estate and gift tax purposes. 
 
It’s all about the appraisal 
The core issue of most disputes on the valuation of art is the failure to prepare the appraisal correctly. The appraisal must comply with the requirements of the Uniform Standards of Professional Appraisal Practice (USPAP) and the Art Advisory Panel of the IRS (Panel). Doing so, lays the groundwork for a successful defense of a collection’s value in the determination of tax liability. Specifically, the appraisal should do three things: shift the burden of proof; use the correct discounting methods; and include the impact of clouded title to the artwork. 

Shift the burden of proof
The appraisal should have enough credible evidence to shift the burden of proof on the valuation and the discount to the service under section 7491(a). Credible evidence here means a quality of evidence which, after critical analysis, the court would find sufficient to base a decision on the issue if no contrary evidence were submitted. Taxpayers have shifted the burden of proof in cases of discounting artwork when they have had, in addition to the base appraisals: 

1. Expert opinion on the general nature of the specific art market at the time of valuation, 
2. Expert opinion on the quality of title documentation,
3. Expert opinion on the reputation of the deceased as a dealer and collector, 
4. Evidence of unsuccessful offers of sale of the entire collection, and
5. Evidence of the method and efforts of the estate in liquidating the collection.
 

Select the correct discounting method
Value discount for lack of marketability - while appropriate in cases where there is a split title or restricted title to the artwork - is not an appropriate discounting method for a collection that was owned 100 per cent by the deceased. The correct discounting methods for such a collection are blockage and lack of liquidity.  

Blockage discount is based on the fact that if the items are offered all at the same time the market would be flooded and the price depressed. Although blockage discounts are commonly used when the collection is the work of the deceased as an artist, for example, Calder v. Comm’r 85 TC 713 (the Calder case), it can also apply to the inventory of an art dealer, as in Janis v. Comm’r 98 AFTR 2d 2006-6075 (the Janis case).  Evidence of the blockage effect is also shown by similar sales of similar collections at about the date of valuation.    

The Calder case also gives the basis for determining the discount for lack of liquidity as the amount of time it would take to dispose of the items one-by-one if sold at full value. This is based both on the factual record of the decedent’s efforts to sell the items before his death, and the efforts to sell the items in the settlement of the estate, as well as evidence of public sale of similar items and opinions by experts on the length of time to sell privately. Additionally, evidence should be obtained from prospective purchasers on what the reputation of the collection is, as often after being on the market for some time the common wisdom is that “all the best items are already sold.”

Consider the impact of unclear title on the pricing
The 2014-2015 USPAP guidelines brought the effect of unclear title to artwork and collectibles in line with the effect of unclear title to real estate for purposes of valuation under the Standard Rule 7. The assumptions that affect the value of the ownership interest in the item now have more consistency across asset classes. Although, some have tried to use this new standard to discount the value of the artwork to zero, as in the Sonnabend estate and the valuation of “The Canyon” by Rauschenberg, at minimum, the 5 per cent to 10 per cent cost of obtaining title insurance on the item should be taken [into consideration].

Specifically, where there are groups actively seeking to claim that the title to the property is defective as “looted” or stolen artifacts in contravention of Federal Law, the question of title makes a dramatic difference.   

Restructure the collection to sell
When a collection is to be sold in an estate, an LLC should be created and the items transferred into that collection during the first six months of the estate as part of the estate administration. The collection can, then, more clearly be shown to be an investment to be transacted, rather than as collectibles. This will most likely not generate any discount, but it can be the basis for an income tax advantage for deduction of insurance, maintenance, storage and other costs during and after administration as well as allowing the estate, or heirs, to use split interest trusts and outright donations of items of clouded title to rationalize and improve the liquidity.