The world of art is a beautiful and mysterious place, however navigating that world takes a lot more than simple good taste. Most of us buy what we like on a piece-by-piece basis, but what makes someone a collector is the talent he or she demonstrates in selecting and grouping their art. This process takes almost as much creativity as the art itself, and requires just as much attention.
From a trust and estate planning point of view, a quality art collection becomes greater than the sum of its parts, and can ultimately set the trend for future generations of art collectors. An admired collection may become much more than a personal passion – it can ultimately be an important part of a family’s legacy with all the pleasures and pains included.
One example we like at Oakstone Law is the Elkins family and the recent federal Fifth Circuit Court of Appeals case of Estate of Elkins v. Commissioner. If you are an art lover or know someone who is, pay close attention to how this unfolds:
Framing the Landscape
Mr. and Mrs. Elkins built a great collection of contemporary art over the years, including Picasso, Pollack, Cezanne and numerous others. As the couple got older, they realized their collection of 64 works had grown to a substantial value. Using careful planning using lifetime trusts (we won’t get into the technical details here) the plan was to transfer the collection to the children during their lifetimes.
Unfortunately, Mrs. Elkins died in 1999, before her part of the lifetime trust planning could complete. So, Mr. Elkins and his advisors did some more careful planning, including the completion of Mr. Elkins’s portion of the lifetime trust planning and a post-mortem technique called a “disclaimer” (see Glossary[link]). .
The end result of all this planning was that when Mr. Elkins died in 2006 he owned one part of the collection and his children owned the rest. But, in addition to transferring the artwork to the children, Mr. & Mrs. Elkins wanted to be sure that there was an agreement in place for maintaining and sharing the collection.
The Artwork Sharing Agreements
During Mr. Elkins’ lifetime, he and his children entered into lease and “Contenants Agreement” with respect to all of the art – both the portion owned by Mr. Elkins and the portion owned by the kids. These agreements had the effect of a partnership agreement, which prohibited any of them from selling, lending or pledging any of the artwork without unanimous consent.
The agreements also spelled out how each partner could request possession of a piece, setting out a fair sharing arrangement. Finally, the agreements provided that each partner would be responsible for a pro-rata portion of the costs of maintaining, storing and transporting the art.
Estate Valuation Discount = Estate Tax Savings
Because the entire collection was encumbered by these agreements, Mr. Elkins’ executor claimed a substantial valuation discount against the value of the collection on his estate tax return. Stated another way, because of the extensive limitations on the estate’s right to sell its portion of the art collection, that portion should not be valued at full fair market value.
The estate’s expert appraiser determined that the estate was entitled to a fractional ownership discount of 44.75% in determining the value of Mr. Elkins’ art collection. What does this mean? In a nutshell, rather than $24 million worth of art being taxed in the estate, only about $13 million was. The estate tax return was audited; naturally the IRS disagreed with this valuation discount.
Tax Court Grants “Nominal” Discount
A Tax Court trial ensued. The estates expert carefully explained his rationale behind the discount methodology used. As noted above, the lease and cotenant restrictions on the ownership reduced the value of the estate’s portion of the collection by 44.75%.
The IRS disagreed, but offered only one relevant expert who simply stated that there was no “recognized” market for partial interests in artwork. Therefore, the IRS conclusion was that because there’s no recognized market for partial interests in artwork, there could be no partial interest deduction in value.
The Tax Court believed that 44.75% was simply too much. But, it wasn’t quite comfortable with “zero” as the discount answer either. So, in a rather arbitrary ruling, the court simply selected a “nominal” discount of 10%.
This 10% would have resulted in a taxable value of about $21 million for the artwork in the estate, and of course increase the estate taxes payable.
Fifth Circuit Court Says “Not so fast.”
The estate appealed to the Fifth Circuit Court of Appeals. In a very well reasoned and articulate decision, the Fifth Circuit dismissed the Tax Court’s rationale. The Fifth Circuit court found that the estate’s appraiser was “uncontradicted, unimpeached, and imminently credible.” On the other hand, the court found irrelevant the IRS expert’s assertion that there is no “recognized” market for partial interests in art.
In other words, the estate experts were lauded and rewarded for professional, thoughtful and well-reasoned opinions and the IRS and its expert were blasted.
Tax Refund of Over $14 Million
Bottom Line: The estate received an estate tax refund of over $14M! What’s more, the family agreements have served to preserve Mr. and Mrs. Elkins’ original intent that the collection be preserved for the family’s enjoyment for many years to come.
This is the “have your cake and eat it too” scenario for many artwork lovers. As a Naples, Florida estate settlement attorney, I hear from clients and friends who worry about the impact their substantial art collections will have on their estates. This impact often has two prongs, as we see in the Elkins’ case:
- First, there tends to be substantial concern over how to reduce the estate tax liability created by the tremendous value these collections have built up over the years.
- Second, there also tends to be concern about how to keep the collection together and make sure that the family can enjoy it without quarrelling siblings and cousins.
The moral of the story: proper estate planning wins again.
Start early by documenting your art with as much detail as possible – catalogue each piece and save receipts. Keep track of your family stories about how the art was acquired and how the collection evolved. And keep your estate planning or probate attorney apprised about your art’s value and significance to you and your family.
If you do have concerns about your art collection, please feel free to get in touch by visiting www.OakstoneLaw.com or calling 239.206.3454.
Oakstone Law is dedicated to helping clients build a solid future by offering a range of services focusing on estate planning and estate and trust settlement (click here to view our services). Headquartered in Naples, Florida, the practice offers easy-to-understand, fixed-cost Client Service Packages, eliminating the traditional hourly rate structure (and headaches). Oakstone Law was founded by attorney Robert Kleinknecht, member of the Florida Bar and Massachusetts Bar. Bob has 15 years’ experience, including serving as a personal, in-house estate, tax and charitable planning attorney for a Forbes 400 family for over 8 years. He also previously served as an estate planning and estate settlement attorney with prominent firms in Boston and Washington, D.C. Click here for more About Oakstone. Click here to ask us a question via the website, or click here to contact us directly.