Many art collectors are driven by a passion for the creative works they spend years educating themselves on, pursuing, acquiring and displaying.
Regardless of how emotionally rewarding these experiences are, financial considerations are also a cornerstone of successful collecting — and inseparable from your intentions for the collection. For serious collectors, the tax and estate planning implications surrounding a collection can meaningfully impact your ability to achieve your goals.
- Investors buy, sell and collect art as an investment with the hope the art will appreciate, enabling a profitable sale
- Collectors collect art for personal pleasure rather than for a profitable investment
- Dealers buy and sell art as a trade or business
- Business collectors buy art for business use, such as displaying in a workplace
Below, we discuss the key dynamics of valuing, appraising and transferring artwork.
How do you value art?
Art has no public, regulated, transparent, full-time market, so its valuation can be complicated relative to, for instance, publicly traded securities or real estate.
- The concept of valuation itself is dependent on the purpose of the valuation being sought — for instance, as discussed below, whether for insurance or gift tax/estate planning purposes.
- While artwork can and often does increase in value, a variety of factors, including rapidly changing styles and tastes, can significantly impact the value of a piece.
- Determining a work’s value may be difficult if the piece is unique, rare, does not have an established retail market or is commissioned.
- It is important to not overlook the satisfaction, years of effort and emotional attachment a collector may associate with a collection, which may not be reflected in the financial value.
That said, broadly, valuation is determined by the following factors:
Authenticity: Authenticity is verification that the work is both genuine and made by the designated artist, and it is the starting point for determining a piece’s value. For significant purchases, buyers should conduct due diligence through an independent expert.
Provenance: Provenance refers to an artwork’s ownership history, auction records, conservation records, certificates and bills of sale, and it is integral in establishing authenticity. Secondly, provenance can help establish that the work was not, at any point, obtained illegally. In some cases, such as prior celebrity ownership, a work’s provenance can add value.
Title: Title refers to ownership of property that is free of claims against it. A piece of artwork could, for example, be subject to liens, serve as security for a loan or be subject to a legal claim. It is critical that, in transferring ownership of art, you are able to defend its title. Note, however, that title is not proof of authenticity.
Rarity: Rarity of an art object can translate into higher value.
Condition: Maintaining a work’s condition is crucial to maintaining its value. Musty rooms, direct sunlight and display over fireplaces can compromise a work’s condition over time, even though — to an untrained eye — it may appear flawless.
How is art appraised?
Beyond knowing how much a work or collection is likely to sell for on the market at a given point, appraisal is also important for insurance and tax purposes. While the nuances of appraisal differ for each assessment, all entail enlisting the service of a qualified appraiser who can prepare an appraisal report according to the Uniform Standards of Professional Appraisal Practice (USPAP).
Insurance appraisals are generally based on retail replacement value (RRV), or the amount it would cost to replace an item with one of similar quality in a retail venue in a reasonable period of time. The RRV will likely be higher than fair market value, which is used for tax purposes, because it is the price one would pay to replace the item at retail, such as a high-end gallery.
Unlike the RRV used for insurance purposes, the value for tax purposes is the work’s fair market value at the time of the transfer, either during life or at death. This value is based on a hypothetical sale in the market in which the artwork is most commonly sold to the public — at auction.
The Smithsonian Institute recommends consulting the American Society of Appraisers, Appraisers Association of America or International Society of Appraisers for membership directories. Remember that it is important to enlist the services of an appraiser with expertise in the relevant type of artwork.
What can I do with my collection?
When planning to ultimately transfer their art, collectors generally choose to transfer the collection to family, transfer the collection to charity or sell the collection. Often, these strategies are combined in order to achieve the desired outcome and goals.
Note that in addition to the topics discussed below, transfers of art can also be made through trust vehicles. Although this can provide financial and control advantages, doing so presents a number of practical challenges and is generally more complex than gifts or bequests.
Transfer the collection to family.
Both lifetime gifts and testamentary bequests, upon death, have varying financial and non-financial advantages. From a tax planning point of view, the key distinction is that gifts are subject to the gift tax, while bequests are subject to the estate tax.
You can gift significant amounts of art during life free of transfer taxes. In addition to the $16,000 annual gift tax exclusion allowed every individual ($32,000 per married couple), you can transfer assets (including liquid assets, real property and tangible personal property) with a total value up to the applicable exclusion amount of $12.06 million ($24.12 per married couple), during life or at death, without federal transfer tax consequences. (Transfers exceeding the exclusion amount incur a maximum 40% federal transfer tax.)
A primary advantage is that the gifted artwork will not be included in your estate, reducing potential estate taxes upon death. Your tax benefit, however, comes at a cost to the recipient: She must use your tax basis (the purchase price or fair market value, whichever is lower) upon future disposition to compute gain or loss for federal income taxes. That is, when she sells appreciated art, she must pay federal and perhaps state capital gains tax on all of the appreciation in the art’s value, not just the post-transfer appreciation.
Conversely, if you were to wait to transfer the art at death, the recipient could receive a new fair market value basis in the art. When included in your taxable estate, the collection’s tax basis is generally the fair market value at the date of your death or alternate valuation date. Depending on your family’s goals for the collection, holding the collection until death and having your executor or trustee provide for disposition may be a workable option.
Case Study: Transferring by Gift Versus Bequest
Donald owns a sculpture with a current fair market value of $1 million. The sculpture's value is expected to appreciate at a rate of 6% per year. Donald has already used his annual gift tax exclusion in 2022 and his applicable exclusion of $12.06 million. He wants his daughter to have the sculpture, but considers whether to transfer the sculpture today as a gift or wait to transfer it upon his death. Assume Donald lives for another 10 years, with gift and estate taxes and exclusions the same as in 2022. If Donald makes the transfer now, he would owe approximately $400,000 in federal gift lax (based on $1 million fair market value in 2022). If he transfers the sculpture by bequest at his death, he would owe approximately $716,339 in federal estate tax (based on $1.79 million fair market value in 2032, an increase of 6% per year). Thus, Donald could save about $316,339 in gift and estate taxes by making the transfer now. However, as discussed below, Donald's daughter will receive his basis in the art in a lifetime transfer.
Transfer the collection to charity.
Collectors often donate their artwork to charity because they have a desire to support specific organizations. In addition, many donors are interested in obtaining a charitable deduction for income, gift or estate taxes. To optimize tax benefits, donors must consider many factors. For federal income tax purposes, the charitable deduction amount depends on the type of property contributed, the type of recipient and how the recipient intends to use the property.
Art held by collectors and investors for more than one year is generally considered long-term capital gain property; income tax deduction for donating long-term capital gain property to public charities is generally based on fair market value of the property, and donors may deduct up to 30% of their adjusted gross income (AGI). By contrast, the income tax deduction for a donation of long-term capital gain property to a private charity is based on the tax basis (usually the cost) of the property and is deductible up to 20% of the donor’s AGI.
Charitable transfers at death are not subject to the same extensive tax deduction requirements (such as AGI limitations and the related use test) as transfers during life. Instead, transfers at death are eligible for unlimited federal estate tax deductions. A charitable transfer at death allows you to benefit from full ownership of the collection during life, and may allow your estate to obtain an estate tax charitable deduction based on the fair market value of transferred items.
Case Study: Charitable Transfer to Museum
Darius is an avid art collector who owns many works by Claude Monet. Looking to collect works by Édouard Manet instead, Darius desires to contribute his Monet collection to a public museum that exclusively displays Monet. The fair market value of Darius' Monet collection is $1 million. He and his wife, Donna, have an AGI of $1 million and live in a state with no state or local income taxes. Darius may deduct $300,000 in the current year and the next two years. In the fourth year, he may deduct approximately $100,000 due to the 30% AGI limitations (assuming Darius and Donna's AGI remains the same).
Sell the collection.
Last, a collector may wish to sell all or a portion of the collection — again, either during lifetime or by their executor at death. There are many different reasons that may drive the collector to sell: for example, diversification of the collection, increased liquidity to acquire a new piece or payment of taxes.
Relative to other assets, art can be expensive to sell due to costs such as auction house fees, sales commissions, insurance, taxes and shipping. If your collection grows in value, it is important to develop strategies to minimize the tax costs of a sale or exchange — which is largely dependent on the timing and relationship between the taxpayer and the art. Broadly, whether you are classified by the IRS as a collector or an investor will determine income tax rates and deductions. You will need to work with your advisors to make these determinations.
The most common ways to sell a piece or collection when or if the time comes are:
Auction: The most familiar method of sale to many, auctions are based on transparent bidding. Works sold at auction typically receive a free auction estimate, and most also carry a reserve price — the minimum price a seller will accept — known only to the seller and auction house.
Private Gallery or Sale: In some cases, those who wish to remain anonymous will opt for a private sale; in others, the auction cycle does not match the parties’ required timeline, or a work can realize stronger prices through private sales than at an auction.
Finally, we would be remiss not to mention non-fungible tokens (NFTs), which are surging in popularity. Demand for NFTs has grown exponentially in recent years and shows no sign of abating, with sales of NFTs increasing seven-fold in Q3 2021 alone, to $10.7B1. However, due to their unique nature relative to more traditional art mediums, the purchasing, tax treatment and financial considerations surrounding NFTs merit a separate treatment. Learn more in What are NFTs? Understand Estate Planning Challenges.