Asset Protection for Art: Issues Arising in the Lifecycle of Acquisition to Disposition

“Asset Protection for Art: Issues Arising in the Lifecycle of Acquisition to Disposition,” that is the subject of today’s ACTEC Trust and Estate Talk.
Transcript/Show Notes
This is ACTEC Fellow Stacy Singer from Chicago.
Art and asset protection are critical components of managing high-value collections, including artworks, historical artifacts and other valuable assets. These protections safeguard against risks like theft, damage and legal issues, preserving the value of assets over time and ensuring they can be passed down through generations or sold when appropriate.
ACTEC Fellows from New York City, David E. Stutzman and Beth Tractenberg are joined by guest Sherri Cohen, who’s also from New York, to educate us on this important topic. Welcome, David, Beth and Sherri. Let me start with you, Beth.
Considerations when Buying or Selling Art Collections
How are art acquisitions, so buying and selling and the legacy of collecting, connected to asset protection? It seems counterintuitive. What are the primary issues making art a unique asset for protection?
Beth D. Tractenberg: Well, that’s very good question, Stacy, because it does seem counterintuitive. However, if you stop to think about it, we all represent clients in our different fields who have large art collections, and those collections are very valuable in both monetary and other ways. So protecting the collections is of paramount importance.
Of course, art can be very valuable from a financial perspective, but there’s more to it than that. Art is a unique asset and owners of art are often very sentimental and emotionally attached to the art. And so that brings with it certain issues that can affect clients’ assets, like having fights over who gets the art at various points in the lifecycle of the art. So we try to protect against family arguments. In addition, there are a lot of special tax rules and considerations that apply to the ownership and transfer of art, either during lifetime or death. And to discuss with us a bit more about the actual qualities of art as art, I am happy to turn this over to Sherri.
Considerations for Art as an Asset
Sherri Cohen: Thanks, Beth. So, you touched upon something that we see a lot which is the emotional and sentimental attachment to art. I mean, if you think about collectors, they’re living with their art for decades and decades.
Art requires a specific expertise, research and market knowledge when you’re valuing it. You’re looking at comparables that have been sold at auction but also in the retail scope, and that’s opposed to the cost or income approach under the use path. And it’s relatively illiquid. So, the major auction sales are happening only a couple of times a year annually.
Of course, there’s a growing robust private sale market, but it might take more time to sell your art. And art has various carrying costs, so we like to think about the capital investment requirements. The biggest cost, I would say, is probably insurance. But there are other costs associated with art, like storage, transportation, security, conservation, and restoration.
And then I would say there’s a whole other slew of marketability factors that impacts the valuation of the asset and hence the protection. We don’t have time to get into them today, but there are things like authenticity and rarity, whether or not the work has been properly legally supported and imported. Whether there are certain regulated materials like ivory or wood that are prohibited from crossing borders. And then, of course, trends tease provenance and subject matter. You might have a harder time selling a religious scene versus a figurative or abstracted matter, but there are lots of considerations when you’re thinking about art as an asset protection.
Stacy Singer: That is really helpful and actually really interesting from my perspective.
So are there any special tax considerations for art when we’re thinking about asset protection? David, maybe you can start us off on that.
Tax Considerations for Art
David E. Stutzman: Well, there certainly are Stacy, especially for collectors, who we are focusing on in large part today; both at the time of acquisition and upon transfer by gift or death. As Sherri mentioned, art is unique, and that includes how it’s purchased. And asset protection with art basically starts at the very beginning, at the moment of purchase, once a price has been agreed upon, whether you’re the high bidder at auction or after negotiation with the gallery, you’re faced in many states with sales and or use tax on the purchase price. And by the way, there are over 14,000 jurisdictions in the US. They charge some form of sales or use tax and they’re not uniform in their rules the rate so we can’t cover them all today.
But a jurisdiction that hosts the largest art market in the country as well as has a lot of collectors, namely New York City, imposes rather high state and city sales taxes and are quite insistent upon ensuring that those taxes be paid. What this means for the collector is that if they buy a work of art in New York, the city will charge an aggregate sales tax of 8.75% on the purchase price, which in the context of an auction sale, includes the buyer’s premium. That doesn’t help the New York resident-collector when they buy but what if the collector is not a New York resident? Will they still own sales tax? It all depends on how delivery is arranged. If the delivery takes place in New York – tax is charged. If it occurs outside of New York – no taxes due. As a result of some very public risk slapping with jail sentences and fines levied on galleries that conspired with purchasers to defraud the taxing authorities.
Most galleries of auction houses now have shipping arrangement divisions that directly arrange for shipment by selecting a carrier and entering into a contract for the shipment of art to purchasers outside New York. So long as an out-of-state buyer uses that dealer or auction house’s shipping division, no New York State sales tax will be imposed. But if they use their own and it’s not a common carrier, New York State tax may be true even if the ultimate destination is out of state. So be careful. First off, how do you take delivery?
Assuming that you avoid the state sales tax on purchases, what about use tax? What happens if you buy the work of art and have it shipped from one state to another? While a state’s sales tax is imposed on sales of tangible property, many states impose a compensating use tax on consumers, such as art that’s used content stored in the state. Use tax generally is imposed on the original purchase price plus shipping and delivery. But that can change if it’s something that has been owned by the collector for a while, that may help you if you move something from one state to another. But if the use tax is the greater of the sales price or what its current value is, it may not be very helpful for you if you’ve got an expensive work of art that has appreciated in value.
New York does exempt personal property purchased by nonresidents that have bought in the state. However, the state treats the term “resident” very broadly. So, for instance, for those Florida ACTEC Fellows who maintain residence in New York and who may wish to move their artwork back and forth between the states or even loan artwork to a New York Museum, you may own New York use tax when you move your painting from your Florida resident to your New York residence, or even if you loan it to a New York museum without consideration.
One way to get around that might be to hold the artwork in an LLC formed in a state without a sales tax, such as Delaware. That may be a way to avoid the use tax when the art is brought into New York. But the LLC must be able to substantiate at least six months of requisite business operations prior to the work of art being shipped into the state. So again, when arranging purchases, moves, and loans, take great care in how those are arranged.
Beth, you might want to speak also about how the taxes on capital gains and estate tax impact the use of art as an asset.
Beth D. Tractenberg: Yes. Thank you, David. There is a lot to say about this.
Art and Capital Gains Tax
First of all, starting out when a collector or anybody sells their art, they’re appreciated art, which is long-term capital gain property, there is a special income tax rate that applies to collectibles. That rate is 28% for federal purposes as opposed to 20%, which is the normal capital gains tax rate for the sale of other investments. So that is something to keep in mind.
And we also have some interesting issues that come up around gifting art and holding art at death. Especially in this year when we are looking forward to the sunsetting of our exceptionally large exemption amount as of January 1st, 2026, many of our clients are looking for ways to use up the full amount of their exemption and we often get questions from clients about, “Well, I have this great art collection, so why can’t I use that and gift? But you know, of course, I would want to keep it hanging on the wall of my house.” Well, that’s a problem because if you give something away but you retain the use and enjoyment of it, it is not a completed gift. So then a question arises.
Well, I know. How about if I put it in my family’s dynasty trust? My wife or my husband is a beneficiary of that trust. So then that can just be used by my spouse and I don’t have to do anything to change where it’s hanging. Well, that might work, but I wouldn’t recommend it. Instead, I would recommend that an appraisal be gotten, if possible, for the fair market rental value of the art and that rent be paid to the trust so that the ownership by the trust is respected. And Cheri has experience with that so I will ask her to weigh in here.
Sherri Cohen: Oh, just a quick statement there. It’s complicated. So make sure that you’re dealing with the right kind of appraisers who are familiar with producing rental appraisals and what that looks like, because there isn’t a very clearly defined rental market for high value art. There might be four decorative things that you would see sort of in a hotel lobby. I’ll pass it back to you.
Considerations for Artists Donating or Gifting Their Artwork
Beth D. Tractenberg: Thank you, Sherri. So the next issue that comes up frequently, which I’m going to touch on very briefly again, is artists. And what can artists expect if they make a gift of art or, for that matter, if they donate art to a museum?
Well, unfortunately, artists are limited to their basis in terms of what they can deduct and what the carryover basis will be in gifting. And an artist basis in his or her work is the cost of the materials used. So for a painter, for example, that would be the cost of the canvas, the paint, the wood, essentially zero. So that’s also something to keep in mind.
When a collector dies with a large collection this raises other issues. There can be liquidity issues if the art is a significant part of the estate, and we don’t ever want to have to have a fire sale. There are also issues of basis step up if art is owned jointly by husband and wife in a community property state, there’s a full step up on the death of the first to die. In a non-community property state, there’s only a one-half basis step up. So consideration can be given to titling the art in the name of the spouse who may be the first to die. For example, if there’s a much older spouse. But even then, we can’t predict who’s going to die first. So it’s a little bit of a gamble.
There are we really don’t have time for this. But I just want to mention there’s special tax issues for nonresident aliens who have places that they live in in the United States, pied-à-terre or beach houses. Many of those people have significant collections and want to keep the art in their home in the United States. That makes the art the United States situs property and subject to U.S. estate tax. So, it’s important to look at ways around having those assets subject to U.S. estate tax. There are a lot of complications with that. And unfortunately, we don’t have time to get into that. But one thing that we do look at in terms of estate tax on art collections is what’s available in terms of discounting the value of that art. And I will turn it back over to Sherri for that portion.
Sherri Cohen: Actually, David, do you want to say a quick statement about Elkins and fractional interest before I turn to blockage discount?
Fractional Interest Discount and Elkins v. Comm’r
David E. Stutzman: Sure. Sherri. As many of our listeners will probably already know, breaking up ownership of artwork can provide opportunities for discounts, particularly as exemplified in the Elkins v. Commissioner case, where the taxpayer and his wife amassed a large collection of major works of art. Following the death of the taxpayer’s wife, he and his children subjected their respective interest in the artworks to significant restraints on possession, partition, and alienation. The IRS in the estate tax audit refused to allow any discounts against the fractional ownership interest owned by the decedent at his death and assessed as very significant estate tax deficiency.
At trial, the IRS, unfortunately for its position, did not defend its position, but the taxpayer’s family produced a panoply of credible expert witnesses to support their valuation. The Fifth Circuit focused on the expert reports and the testimony of the taxpayer’s daughter, who is a co-executor, and found great import to her, quote, “psychic attachment to the art,” as well as to the experts conclusions and accepted a 44 ¾% fractional interest discount in valuing the undivided fractional interest in the art.
Now, Elkins may present you with what appears to be a promising template for asserting a discount for fractional ownership. But remember, the IRS probably will not be caught flat footed again in not presenting evidence to support its position. So if you find yourself in this situation, be prepared for the asserted discovery question and make sure your facts and your expert opinions are ironclad.
Blockage Discount of Art
Sherri Cohen: Thanks, David. I’ll pick it up from there. One more discount that we want to address is the blockage discount. So first, taking a step back. As a practical matter, you need your fair market value appraisal, and when you’re taking a discount, you layer on top of that the analysis and the justification for the discount.
Unfortunately, there is no straight-line approach, we wish, it’s a very fact-dependent exercise. So David talked about fractional interest. The other major discount category for art is what we call blockage. It mostly arises in artist’s estates but can also apply if there is an estate of a prolific collector, investor or gallerist. Anyone who has a large amount of works by the same artist maker. It can even apply, you know, if you have thousands and thousands of prints.
But the rationale is an economic concept. If you’re introducing a large supply onto the market at one time, you’re flooding it and you’re going to temporarily decrease the price of certain works. So I can run through three cases, but there is we’re actually blessed with a lot of case law in this area is you tend. Think of the David Smith tax case from 1972 as the seminal case where this was permitted and allowed a 37% discount. They didn’t really get into too much detail of the rationale, but it boils down to this assessment of the present value versus an assessment of future earnings. And the court looked at the fact that if you know David Smith’s heavy metal works, they were located in a relatively remote location in upstate New York. And the theory was that all of the works would have to have been sold to the same buyer, presumably a dealer at one time.
The next big case is the Alexander Calder case from 1985. It’s actually not an estate case. It’s a gift taxes case. And the petitioner was the artist’s widow who took a 60% blockage discount successfully on the passing on the first death, and then tried to do it later in a gift tax context. And the IRS was opposed to that because they said the nature of gifts is something in the future. It’s actually not true. You can take a discount on gifts. And they looked at sort of an annuity approach, looking at how many works had been sold since the artist’s death and doing a math calculation that landed around 10%.
The last case, which I’d say is probably my favorite case, because it makes the most sense to me as someone in the art world, as the Georgia O’Keeffe case from 1992. She died bequeathing a number of works to museums. The whole estate was worth 72 million. There was a lot left in the residue, and the IRS took the position that you cannot discount works that are to be gifted. They said that the disposition was relevant. The tax court took issue with that and said, actually the ultimate disposition is irrelevant to the discount, and they divided the works into two categories: the bucket approach- so the more desirable works that you can sell faster got a lesser discount of 25%, and then the less commercial works that are a little bit more difficult to sell and then back to the carrying costs, got a discount of 75%. So that boils down to what I call the bucketed quality approach.
Stacy Singer: That is so interesting and so much information I had no idea about. So that’s great. So let me ask one last question. We know art is often held by couples and by families. So how can art be protected in a marital breakdown in divorce or if there are multiple marriages? David, maybe you can kick us off on that.
David E. Stutzman: Well, very briefly, I think, as Beth alluded to earlier in our conversation, there are ways to protect interests of the family in an art collection. And one way of doing that is to transfer art or collectibles to a family entity, such as FLP (Family Limited Partnership) or LLC, and that can provide numerous benefits: creditor protection, centralized ownership and management, opportunities for equal and perhaps tax-advantaged gifting during life, as well as potential tax savings. But you have to be very careful of all the various cases where the IRS has successfully challenged discounts on valuations of interest at death.
I won’t go into great detail, but as we all know, in the context of LLCs and FLPs and that helps it allows for more centralized management, it allows for gifting of interests in an entity as opposed to the individual works of art, which is very difficult as art is a rather unique characteristic and allows for centralized insurance coverage, storage, maintenance, conservation of the collection and protection from creditors. I think that has a much more detailed description of those types of creditor protections in the context of divorce and in family harmony.
Art and Prenuptial Agreements & Family Dynamics
Sherri Cohen: Thank you, David. Given our time constraints, it’s not going to be so detailed, but obviously, where there is a large art collection, or it is anticipated that there may be a collection during marriage, these issues can be addressed in a prenuptial agreement so that the parties rights and claims against the art can be hopefully addressed at the beginning and not leave to a later divorce the time to argue about possession and division of the art collection.
In terms of family harmony, something I am very firm about with clients I work with, is the importance of family meetings to discuss the disposition of art, especially on the death of the second to die of parents. I have found in my practice that the children often fight over many items. It doesn’t necessarily even have anything to do with the particular items. It may be unresolved issues from childhood, but at any rate, when I have been able to convince families to sit down and discuss their ideas about the disposition of art, it’s very interesting because often siblings have diametrically opposed ideas about what should be done with the collection. And having the family meeting ahead of time when emotions are not running high can be very useful and save a lot of time and aggravation, and money, which protects the family’s assets.
Stacy Singer: This has all been such great information and something certainly I think that many of our listeners probably don’t know a lot about. So thank you, David, Beth and Sherri, for a great conversation on asset protection for art and the issues that arise in the lifecycle of acquisition to disposition. Thank you for listening.
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