Maroney Law Blog

Thursday, October 30, 2014

Artwork Valuation and the Estate Tax

Many wealthy families with art collections are faced with costly decisions when determining how to address their art collections for estate tax purposes. Questions such as these often prompt families to consult a trust and estate attorney who can advise and fight on behalf of their clients.

The conundrum that art collectors face is when to sell their collections. If a collector sells the artworks while they are alive, they are subject to a 28% (currently) capital gains tax on any appreciation in the value of the art. However, if the art owner retains the art until death, up to 40% of the entire market value of the artwork could potentially be taxed under the estate tax (which currently provides a $5.34 million exemption).

Thus, for families who are nearing the estate tax exemption mark or are currently over it, the choice of whether to sell, gift, or donate the artwork can have huge financial implications, as assets above the exemption mark are taxed at a top rate of 40%.

Recently, the Fifth Circuit issued a decision which weighed in on how some families may be able to lower the rate at which artwork can be taxed.  The court granted a prominent family a $14.4 million estate tax refund and affirmed the use of fractional interest discounts for works of art.  This allows some families to creatively reduce estate taxes. The case involved 64 pieces of art whose worth, based on their full fair market value, totaled $24.6 million.

Anticipating future estate and gift tax issues, the family executed various planning techniques to divide ownership interest in the artwork. These techniques included a Grantor Retained Income Trust, a co-tenancy agreement, a lease, and a disclaimer. Essentially, by the time the grantor passed away, he held a 50% interest in three of the works and a 73% interest in the other 61 works. His three children held the remaining interests.

However, the IRS maintained that a tax discount for such fractional interests was unallowable. Thus, for tax purposes, the art would be valued based on the fair market value with no regard to the fact that the works were, in effect, owned by more than one individual.  

While the Tax Court disagreed with the IRS’ position that such fractional ownership discounts for artwork were unallowable, the court wrongly applied its own arbitrary 10% discount. In overruling the Tax Court’s decision, the Fifth Circuit held that the family’s personal valuation of the discount was applicable. 

As the Fifth Circuit held, “…in the absence of any evidentiary basis whatsoever, there is no viable factual or legal support for the court’s own nominal 10% discount,” and: “The Estate, as taxpayer, presented all of the evidence and a surfeit at that, further eschewing the propriety of a nominal discount.”

This simply means that, because the estate provided support for its valuation based on the fractional interest in the works of art, it was up to the IRS to rebut the estate’s evidence. Furthermore, the Tax Court erred in deciding that the discount should amount to 10% without any evidence.

Strategic planning can help families prepare for unexpected estate tax burdens. If you have any questions about how art and other collectibles may be valued for the purposes of taxation, contact the experienced estate attorneys at Maroney Associates, PLLC. 

Based in Melville and Garden City, New York, the attorneys at the Law Offices of Maroney Associates, PLLC assist clients throughout Nassau County, Suffolk County, Queens, and the cities of Mineola, Hempstead, New Hyde Park, Franklin Square, Williston Park, Queens Village, Melville, Huntington, Farmingdale, Patchogue and Uniondale, NY.

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