Art and Collectibles – Part II

Summary:

Last month's checklist addressed record keeping and income tax consideration for your art and collectibles. This month's column addresses additional issues. The topic is so broad and complicated that the following should be viewed at most as a starting point to make you aware of some of the many issues to consider.

Appraisals.

Appraisals of art and collectibles is common, and an important component of planning.  Most people assume that all appraisals have the goal of determining the value of the art or collectibles being appraised. But "value" has many definitions depending on the context. You have to clarify the correct definition of "value" to obtain the desired result.

■ An appraisal to be certain your art is appropriately insured should be aimed at identifying the "replacement value" of the property. This is the highest price that would be required to replace a property with another of similar age, quality, origin, appearance, provenance and condition. The replacement purchase should be assumed to be consummated within a reasonable length of time, and in an appropriate and relevant market. Similar items are those from comparable manufacturers, craftsmen, artisans, designers, using similar materials, close in size, date, importance, similar aesthetic qualities, and appearance.

■ If you're planning a gift of collectibles to your children or a charity, for tax purposes your appraiser should be directed to determine the "fair market value", as that term is defined in the tax laws. "Fair market value" is defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts. Treas. Reg. Sec. 20.2031-1 (b).  The appraisal report should identify, compare and contrast recent sales of comparable items sold in the market where the items are most commonly traded.

■ A qualified appraisal must be prepared, signed, and dated by a qualified appraiser. The appraiser should: hold himself out to the public as an appraiser or performs appraisals regularly; be qualified by background, experience, and education to make appraisals of the type of property being valued; not be the donor, donee, or someone employed by the donor or donee, or the dealer who sold the art to you; not charge based on a percentage of the appraised property; understands that an intentionally false or fraudulent overstatement of the value of the property may subject the appraiser to a civil penalty under IRC Sec. 6701;  understands that a substantial or gross valuation misstatement resulting from the appraisal used in connection with a tax return may subject the appraiser to the penalty under IRC Sec. 6695A; and is not barred from presenting testimony by the Office of Professional Responsibility, Reg. 1.170A-13(c)(5). 

Estate Planning.

There are a myriad of estate planning implications and considerations to your holding art and collectibles. The following discusses a few of these.

■ Code Section 2036(a)(1) is a major landmine in estate planning in that it can pull assets back into your taxable estate based on your having retained some inappropriate "strings" to the asset involved. Property transferred by your, during your lifetime, is brought back into your gross estate if you retain the right to receive the income from the property, or if you retained the "possession or enjoyment" of the transferred property, for: (1) life, (2) a period ascertainable only with reference to your death (e.g., monthly, except for the month in which you died), or (3) a period that does not in fact end before your death (e.g., 5 years if you died during this period).  So if you give your daughter your Miro, but you retain the right to display the painting in your home for your life, the full value of the Miro is taxable in your estate regardless of the "gift".

■ Tax allocation clauses in your will are vital to address. Many wills allocate the tax burden in proportion to the value of assets given. However, if one heir receives a bequest of $3 million in securities, and your other heir $3 million in collections, how will the heir with the collections have the cash to pay his share of the estate tax? Think through "standard" clauses to make sure the result is what you actually intend.