How Estate Planning Can Get Complicated If You Have An Art Collection

According to conventional wisdom, art lovers should always buy to their tastes rather than looking for something with the potential to increase in value. Yet even if you go down this route, it is important to consider financial matters when it comes to leaving a will. After all, you need to be aware of what will happen to your art once you’re no longer able to enjoy it.

The Importance of Planning

The larger and more valuable your art collection gets, the more significant it becomes in terms of finance and tax. According to Michael Deglass of New York financial planning firm Sontag Advisory, there are intangible and tangible aspects to estate planning just as there is in art collecting. He points out that those who inherit the art may be hit with some nasty taxes.

Remember, just because you’re an art lover doesn’t mean your family is; so if you intend to leave them your collection, you may be allocating family resources to something not everyone appreciates.

Fortunately, there are specialist advisors available and they typically focus on legal and tax concerns in philanthropy and estate planning. These advisors sometimes specialise in a very narrow art niche which enables them to help clients find the right artists for their collection based on the taste of the client.

Advisors believe that the lack of a set value on art can actually work in the favour of investors. According to Jordan Waxman of New York firm HSW Advisors, the value of art changes depending on whether you plan to donate it, lend it or keep it. Although art is not an asset capable of helping you meet your retirement goals or deal with lifestyle issues, it can be an excellent tool for wealth transfer.

For example, if you wish to leave a valuable painting by Picasso to your loved ones, ensure it is valued at its lowest possible level. In most nations, transfers to heirs are hit with high taxes but the amount needs to be relatively high for the full force of the taxes to be felt. Since Picassos similar to yours are seldom sold, ascertaining a value is tricky. As a consequence, tax authorities are likely to accept a fairly low estimate; obviously, this estimation needs to come from a qualified appraiser.

Liquidity

As art is not a liquid asset, you can appraise it for less for gifting purposes. If there have been no comparable sales recently, a £3 million painting could easily be estimated at £1.8 million. As much as the lack of liquidity is good for estate planning, it can be a problem in other ways. For instance, the sale of shares is recorded as a public event but with a painting, it’s possible that a taxable event may be created which hurts your heirs in the future.

While you can simply take the Picasso off one wall and place it on the other as a non-documented transference of property to avoid taxation, it is not a legitimate transfer which can cause all sorts of problems later on.

According to Deglass, having an illiquid asset that creates a liquid liability is bad news for heirs. So if your heirs get £6 million worth of artwork and £6 million worth of liquid assets, they may end up with a huge estate tax bill of up to £6 million (depending on where they live). In this case, they will either have to pay the bill and keep the art or sell the art in order to pay the tax. Unfortunately, art buyers have a talent that enables them to sense desperate sellers which means they will probably pay a lot less than £6 million for the art.

Transferring Ownership

Financial planning usually involves the alteration of facts on paper without altering the facts on the ground. There are a number of techniques used by advisors to transfer art ownership but NOT the art collection itself. For instance, you can sell your art to heirs for cash (or else they can promise to pay); alternatively, you can place it in a trust and lease it back. While these strategies can provide tax advantages, they may not get by the beady eye of tax authorities.

Trusts/collections are useful tools to help you and your heirs to avoid bad luck. In many tax codes, your property will be hit with estate tax in the place where you die. For instance, you may be placing your Monet on a wall in your second home in Montreal but die when changing planes in New York. In this instance, the U.S. tax code will be used to assess the estate tax on the Monet.

If you’re not an American citizen or were resident there when you died, only the first $60,000 of the Monet’s value will be free from tax. Compare that the $5.43 million that would be tax free if you were an American citizen. As well as being bad luck, the above is an example of bad planning according to experts.

If you are not a United States taxpayer but have an asset in the U.S, your asset will be subject to American estate tax laws if the asset is there when you die. An easy way around this is to place the art in a trust which absolves you of ownership as an individual.

Tax Efficiency

Advisors also provide details on being a tax-efficient philanthropist so if you give art to a museum for example, you should get an appraiser to boost the value of the art collection to give you a better tax write off. If you lend the work to any institution or remain as a ‘part’ owner and donate the rest, you be able to retain ownership of the art for a while and also receive a tax break.

The law varies around the world but in the United States for example, you can allow a museum for instance to use the art for a certain amount of time annually and take a charitable deduction sum based on the art’s value that is prorated. However, you need to either give away the art entirely within 10 years or when you die (whichever event happens first) and the deduction will be based on the art’s value at that point or when you donated the fractional interest (whichever amount is lower); penalties will be due if the deductions are deemed to be too high.

With valuation rules stricter than ever before, gifting fractional interests is no longer a suitable solution. As complicated as art and estate planning is, the unique nature of the market means you can use it to your advantage as long as you hire the right advisors and begin planning early.

Note: This article relates to American law