Estate Planning with Art
“Estate Planning with Art,” that’s the subject of today’s ACTEC Trust and Estate Talk.
This is Constance Tromble Eyster, ACTEC Fellow from Boulder, Colorado. Given their unique financial characteristics and the passionate goals of collectors, art and other items of tangible personal property are some of the most difficult assets to incorporate into an overall estate plan. To learn more about this topic, you’ll be hearing today from ACTEC Fellow Ramsay Slugg of Fort Worth, Texas. Welcome, Ramsay.
Thank you, Connie. And you are exactly right. Art, I think, is the hardest asset to plan with, and there are a couple of reasons for that. First of all, it’s a very emotional asset. So, we have people that go out, they see some art. It catches their eye. It catches their heart, and they become absolutely passionate about collecting art. And it goes from decorating their house to becoming just a full-blown lifestyle. The other thing that makes it so difficult is cash flow. Now most of the techniques we like to use that are so effective with estate planning — Grantor Retained Annuity Trust, sales to an intentionally defective trust, a Charitable Lead Annuity Trust or a Unitrust — all of those things work much better when we have cash flow within the trust that can pay the annuity payment. They can pay the Unitrust payment; they can pay the note–interest and the principal. We don’t have that with art. In fact, not only do we not have cash coming in that we can use to pay those parts of those techniques, we’ve got cash flowing the other way because art is not only expensive to purchase but it’s expensive to curate. It’s expensive to own. So, there are ongoing expenses for a variety of things.
Now, you add on top of that, that collectors are collectors. Notice we don’t call them art disposers. They collect. They don’t like the idea of selling. They don’t like the idea that their art is going to be disposed of some day. This has become part of their lifestyle. They go to art fairs. They go to auctions. They go to museums. They like this socializing that goes along with it. Their friends, and of course, it’s been hard this year with COVID, that they haven’t been able to do some of those things, but they still continue to do some of those things online to the extent they can. It’s not like buying and selling stock or other assets. It’s way beyond that. It’s really a lifestyle.
Now still, at some point, there’s going to be a disposition. Even the Egyptian kings couldn’t take it with them. They tried, but that lasted for about 2000 years, and then all their things got dug up and taken away. So, nobody gets to take it with them. Clients, when they go through this process and they realize it, I think that they become confused because they think they have more choices than they really do have. They think, well I could give this piece to little Suzy. This could go to cousin, Tommy. I might sell this. I might give this to the church. I might give this to the food bank. And by the time they get done, all of a sudden, it seems like they’ve got 167 different choices. But they don’t. They really only have three; and there it becomes like every other type of asset. They’re either going to have to sell it, they’re going to have to give it to their family or other non-charitable beneficiary, or they’re going to donate it to charity. Three choices — sell, give, donate. And there are two times they can do that. They can do that when they’re living, or they can do that at death. Now, if you’re going to wait until death to do it, it’s best to set it up during life and not leave it to chance.
What I do with clients is, I take them through those six options; and I want them to understand the tax effect of each option and also the non-tax considerations. And it’s important to understand that these six options are not mutually exclusive. They are exhaustive. There are no other options. But some clients, it’s not like we get to the end and the clients say, well, I’ve heard all six, which one should I pick? Which one is best? They don’t have to pick. They may do all six. They may do four. They may do one. It just depends on what’s going to work out for them. So, let’s review these briefly to see what works in different scenarios.
Selling Art During Lifetime
First of all, if we’re going to sell part or all of the collection, it is better from a tax point of view to do that at death. And the reason for that is if we sell during life, we have a very high capital gains rate. Right now, it’s up to 28 percent. That may change in the future. But right now, it’s 28 percent. Plus, there’s a 3.8 percent healthcare surtax. Plus, depending on where you live, you may have state income tax. And you add all that up and that can take a big bite out of any capital gain that you might have in the asset. Now what’s left over, the residuum, at some point, with any clients — would-be collectors — there’s going to be an estate tax. And right now, that’s 40 percent. So, if you take that 28 and the 3.8, and the state income tax, plus you take 40 percent on the residuum, pretty soon you may be at a 65 or more percent tax rate. That’s pretty expensive.
So, if somebody is going to sell, it’s better to wait until death and all those income tax considerations go away. They’ll still have to pay estate taxes if they have a taxable estate. If they don’t have a taxable estate, they won’t pay any tax because they’ll get a basis step-up under current law. The added bonus is the reason they bought this art is because they love it, and they want to look at it. And if they’re going to wait until death to sell it, they get to continue looking at it the rest of their life.
Gifting Art During Lifetime
The second choice is to give it away. Now, this is sort of the opposite. Even though gift taxes and estate taxes, under current law are at the same rate, the way we calculate gift taxes makes them cheaper. So, if we make a gift during life as opposed to waiting until death, what happens is that we’re going to pay a lower tax rate, effective tax rate, plus we’re going to give away future appreciation in the asset. So, from a tax point of view, it’s much better to give it away during life, sooner rather than later. The opposite from selling, which is later rather than sooner. And we don’t have time here to get into a lot of different techniques about that, in different ways that people try to deal with that particular issue. But there are some techniques to try to deal with giving it away, without giving it away.
Donating Art to a Charity
Finally, we have donating to charities. And a lot of clients say, you know, art is awfully expensive to sell; it’s awfully expensive to give away in the sense of an opportunity cost. So, I think what I’d really like to do, to keep my collection together, is donate it to charity. And that really is the most effective way from a tax point of view to keep a really significant collection together. And if you look at most of the museums in the country, in the world really, they’ve really started from one person’s collection. I gave some examples, usually when we have longer and I speak about it, at different museums, they usually have somebody’s name on the door. And that’s usually because of his/her collection that started the museum.
Now, we can wait until death to give the art to charity. But we’re going to forego a very valuable tax benefit if we do that because if we give it during life, we’re going to get a charitable income tax deduction. And if we do this correctly — and there are a lot of rules, obviously, you want to make sure that you’ve got somebody who’s involved who really knows these rules — we can get an income tax deduction of the fair market value of the art up to 30 percent of the adjusted gross income; and we have a five-year carryforward for anything that is excess over the current year’s income.
There are a lot of rules to follow. But there’s one, in particular, you really want to make sure that you follow, and it’s called the “related-use rule.” And what that basically means is that if I’m going to give it to a charity, I need to make sure it’s a charity that’s going to use it as part of its tax-exempt purpose. What I like to have clients do is to get that in writing, to get that from the charity that they have a bona fide intention at the time of donation that they will use it as part of their tax-exempt purpose. And if that’s the case, then you get a fair market value deduction. If you give it to them and they turn around and they have no intention of using it — in fact, they’re going to turn around and sell it at a charity auction, then you’re going to get a cost basis deduction, which could be substantially different.
Conclusion – Estate Planning with Art
There are a lot of substantiation rules. There are a lot of appraisal rules. They are very strictly construed. So, you need to make sure you follow those. You need to make sure that you use an advisor, an advisory team that knows these rules and knows who to contact within the industry to do this. So, whatever you do, whether you decide to sell, whether you decide to give it to your family, whether you decide to donate it to charity, whether you do that during life or you do that at death, the important thing is that you plan. Don’t leave it to chance. Because I will guarantee you, if you leave it to chance, something different from what you would have intended if you had thought about it, will be the ultimate result. So, please plan and please use experienced advisors. So, Connie, I’m going to stop there and thank you; thank you everybody for joining today and I hope you found this to be valuable.
Thank you, Ramsay, for those wonderful tips on estate planning with art.
You may also be interested in Litigation Issues in Art Law.
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