Tax-Efficient Planning Strategies for Art Collectors by Lewis Kevelson, CPA
Posted on January 09, 2020
Art collectors who accumulate artwork over their lifetimes tend to have limited interest in selling any of the pieces in their collections, according to a recent study conducted by UBS. Instead, most collectors develop an emotional attachment to the artwork they acquire and prefer to display their collections in their homes for their own personal enjoyment. When this is the case, collectors may not consider what will become of their collections after they pass away or how those pieces will impact their taxable estates and family members after death. Absent any advance planning, an art collection will become a part of a decedent’s estate, at which time, it may be subject to significant estate taxes and forced sales to raise cash needed to settle IRS and other debt obligations. Moreover, heirs may not have the same attraction to or passion for the art as the original collector.
The changes to U.S. income and estate taxes brought about by the Tax Cuts and Jobs Act (TCJA) in 2017 have required taxpayers to rethink existing strategies for wealth preservation and tax efficiency, especially for high-net-worth collectors who spent significant time and dollars amassing collections of highly valuable art and other appreciable assets, including classic cars and vintage wines.
On the positive side, the new law nearly doubles the federal estate & gift tax exemption, which allows individual taxpayers to exclude up to $11.58 million from a 40 percent estate and gift tax in 2020. With some general planning, married couples can exclude up to $23.16 from estate and gift tax in 2020. However, this favorable provision of the law is set to expire by 2026, at which time the estate and gift exemption will return to its pre-2018 level of $5.49 million.
Proceeds from sales of artwork held for one year or more continue to be subject to long-term capital gains tax at a rate of 28 percent, plus a 3.8 percent surtax on net investment income (NII). Art held for less than one year is subject to income tax at the taxpayer’s ordinary income rate plus the 3.8 NII tax, which can result in a total top rate of 40.8 percent.
Tax-Efficient Planning for Art Collections
Although the higher gift and estate exemptions under the TCJA are set to expire in 2026, upcoming elections and future tax legislation can change this to an earlier date. Thus, tax-savvy collectors should be planning now to take advantage of the currently generous estate and gift exemptions.
Following are just some of the strategies collectors may want to consider in the current year to manage their collections and plan for passing those legacies onto future generations.
- Obtain an updated appraisal of the collection to understand how it can impact your overall estate-tax picture. Pay special attention to your estimated estate-tax exposure and if you have enough existing liquidity to settle the estate tax that is due nine months after a collector passes away.
- Discuss the collection with your family members to determine if they have any interest in continuing to manage the collection after the collector’s death. Based on the TCJA, a collector with no previous gifting activity can pass up to $11.58 million of their collection tax-free to family members. A husband and wife can jointly gift up to $23.16 million to heirs. As part of the gift-planning process, collectors should locate original documentation to help support the artwork’s history and income-tax cost basis. A tax accountant can help to determine the cost basis when the collector did not acquire the property directly.
- Consider the benefits of gifting the collection to a museum or a not-for-profit charity that can display the donated artwork as part of its permanent collection. A charitable gift generates current-year income-tax deductions for collectors without using up any of their individual $11.58 lifetime exemptions.
- Consider selling less-favorable pieces now to avoid a liquidity problem for your estate (and heirs) in the future. However, recognize that a sale in the current year will result in immediate federal income tax liabilities as well as state-level tax obligations, depending where the collector lives.
- Consider establishing your own private museum to keep your collection intact. This planning strategy is most appropriate for large collections in which the collector has the means to support the high, annual fixed costs of managing and maintaining a private museum. There are a number of other estate-planning strategies to help collectors reduce the impact of state taxes. For example, an elderly collector with a taxable estate can structure a transaction to transfer the collection to his or her heirs during life in exchange for an annual annuity payment. The annuity would be designed to terminate upon the death of the collector and help to protect the collection from being included in the collector’s post-mortem estat
Planning for the orderly transfer of a collection takes significant time and resources under the guidance of experienced financial advisors and tax accountants. Moreover, it is critical that collectors communicate their wishes and plans to future generations so that the collection can be properly dealt with at the time of the collector’s passing.
About the Author: Lewis Kevelson, CPA, is a director with Berkowitz Pollack Brant’s International Tax practice, where he helps high-net-worth families, entrepreneurs and business owners structure transactions to comply with domestic and international tax matters while building and preserving wealth. He can be reached at the firm’s West Palm Beach, Fla., office at (561) 361-2050 or firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.