The development of art as not just a form of personal enjoyment and expression, but as a significant asset class, has tax, structuring and estate planning implications. Although the author of this article examines the details within a North American setting, it also has relevance in other parts of the world.

A regular author in these pages is US-based lawyer Matthew Erskine, managing partner at his firm Erskine & Erskine. This article touches on the way that art can and sometimes does fit into estates and trusts, and other structures requiring advice. The editors of this news service are pleased to share these views; the usual editorial disclaimers apply. To comment, email tom.burroughes@wealthbriefing.com

Art, no longer just a form of personal expression or aesthetic appeal, has evolved into a significant asset class with complex valuation considerations. The valuation of art for gift and estate tax purposes is a nuanced process, requiring a sound understanding of not just the art market, but also the intricacies of tax laws and regulations. This article provides an overview of the methodologies and challenges encountered when valuing art for these specific tax purposes.

When transferring an asset through a lifetime gift or estate settlement, you have the option to gift it to either an individual or a charity, either directly or through a trust. Regardless of your choice, it is crucial to report the fair market value (FMV) of the asset and potentially fulfill tax obligations. In the case of charitable gifting, you may also be eligible for an income or estate tax deduction.

Determining the FMV of publicly traded stocks and bonds is relatively straightforward due to their fungibility and the availability of market prices for similar investments on the day of transfer. However, assessing the FMV of illiquid assets such as privately held companies, real estate, and tangible property presents more challenges. This is especially true for artwork and collectibles, where the assets are not only illiquid but also unique. Finding comparable sales, such as those available with publicly traded investments, becomes difficult.

It is important to navigate these complexities to ensure accurate valuation and compliance with tax requirements.

To determine the fair market value (FMV) of illiquid assets, it is crucial to obtain an appraisal that complies with the Uniform Standards of Professional Appraisal Practice (USPAP). In the case of artwork and collectibles, the appraisal must also meet the standards set by the Art Advisory Panel of the Internal Revenue Service. Often, especially in estate situations, this appraisal process is expedited due to the requirement of filing an estate tax return within nine to 12 months of the date of death. To avoid the inevitable errors that arise from hasty actions, we strongly urge all art and collectible owners to initiate an inventory during their lifetime that adheres to USPAP and the Art Advisory Panel standards, at the very least.

When describing an item, whether it's a physical object like a coin or something intangible like copyrights, it's crucial to maintain consistency in the descriptive terms and references used. This consistency ensures clarity and avoids confusion. For example, if one item is attributed to Michelangelo di Lodovico Buonarroti Simoni and another item is simply attributed to Michelangelo, it can lead to the assumption that they do not refer to the same artist. 

To ensure reliable and consistent descriptions, the Getty Categories for the Description of Works of Art (CDWA) provides a comprehensive schema for describing artworks and collectibles. By following this schema, core records of artworks can be consistently and accurately described. 

For an example of a catalog description, you can visit the catalog description for Vincent Van Gogh's "Irises."

When describing an item, it is crucial to consider both visual and textual data. Furthermore, each record should include references such as location, ownership, medium, concept, and subject matter. Ideally, if the description refers to an authoritative record that may not be easily accessible online, such as an auction catalog, it would be advantageous to include a digital image of the relevant reference or modify an existing record to incorporate it into the appraisal process.

Checklist for Appraisal: USPAP and Art Advisory Panel Standards
When reviewing inventory for an appraisal, it's important to consider the standards set by both the USPAP and the Art Advisory Panel. Here's a checklist to guide you:

Basic Information:
-- Identify the owner(s); 
-- Determine the intended use of the description; and 
-- Define the type and value of the artwork, including cash value, financial arrangements (e.g., collateral for loans), and any non market financial conditions or incentives that may affect value.

Complete description:
-- Provide a comprehensive description of the artwork, including the artist's name, title of the work or subject matter, medium, creation date, size, marks or labels, provenance, exhibition history, and physical condition; and
-- Include a high-quality photograph that fully showcases the artwork.

Additional considerations:
-- Assess the quality of the artwork within its category; 
-- Evaluate any physical or economic attributes that impact its value; 
-- Determine ownership interests and any known restrictions; 
-- Acknowledge any extraordinary assumptions or hypothetical conditions; and 
-- Define the scope of work required for a credible appraisal.
 

Further information:
-- Conduct a comparative sales analysis when necessary; 
-- Consider costs, including the comparable cost of new property and accrued depreciation; 
-- Evaluate income, including market income, operating expenses, capitalization rates, and discount rates; 
-- Account for any encumbrances or pledges affecting value; 
-- Assess the value of the artwork as part of a collection, including sales of similar items and the impact of selling the entire collection; and
-- Consider the market effect of repairs, restoration, or modifications.

While building an inventory that meets these standards may appear daunting, it is indeed achievable. Begin by creating basic descriptions and gradually add more information over time. To streamline the process, we highly recommend using an online collections management application. This will not only reduce appraisal costs and minimize errors but also assist with gift and estate tax returns, ultimately lowering the likelihood of an audit.

Shifting the burden of proof
To establish the value and discount applied to the service under section 7491(a), the appraisal must present credible evidence. Credible evidence, in this context, refers to evidence of sufficient quality that the court would consider appropriate for deciding in the absence of contradictory evidence.

Taxpayers have effectively shifted the burden of proof in cases involving the valuation of artwork by providing additional supporting elements. These elements include expert opinions on the specific art market's prevailing conditions at the time of valuation, expert opinions on the quality of title documentation, expert opinions on the reputation of the deceased as a dealer and collector, evidence of unsuccessful offers to sell the entire collection, and evidence of the estate's method and efforts in liquidating the collection.

When evaluating the appropriate method for discounting a collection owned entirely by the deceased, it is crucial to consider the context. While a discount for lack of marketability may be suitable for artworks with split or restricted titles, it is not applicable in this case. Instead, the blockage and lack of liquidity methods are more appropriate.

The blockage discount considers the potential market flood and subsequent price depression that would occur if the entire collection were offered simultaneously. This discount is commonly employed when valuing collections by deceased artists or even the inventory of art dealers. 

Evidence of the blockage effect can be supported by examining similar sales of comparable collections around the valuation date.

The Calder case provides valuable insights into determining the lack of liquidity discount, which considers the time required to sell each item individually at its full value. This determination relies on factual records of the decedent's efforts to sell the items before their passing, as well as the estate's selling efforts. It is also crucial to consider evidence from public sales of similar items and opinions from experts regarding the timeframe needed for private sales. Additionally, gathering input from prospective purchasers on the collection's reputation holds significance, as it is often perceived that the best items have already been sold after being on the market for some time.

Considering the impact of an unclear title on pricing is of utmost importance. The USPAP guidelines align the effect of an unclear title on artwork and collectibles with that on real estate for valuation purposes under Standard Rule 7. This brings more consistency to the assumptions influencing the value of the ownership interest across different asset classes. 

While some have attempted to devalue artwork to zero using this new standard, as seen in the Sonnabend estate and the valuation of "The Valley" by Rauschenberg, it is prudent to at least account some significant discount to the value of the item. Particularly, when active groups claim that the title to the property is defective, such as in the case of "looted" or stolen artifacts in violation of Federal law, the question of title becomes even more significant, and the item may become more of a liability than an asset in the estate.

Selling a collection during administration
To effectively sell a collection during an estate process, it is advisable to create a limited liability company (LLC) and transfer the items into it within the first six months of administration. This approach establishes the collection as an investment rather than just a collection of collectibles. 

While this may not result in immediate discounts, it offers potential income tax advantages by allowing deductions for insurance, maintenance, storage, and other associated costs both during and after the administration period. Additionally, it enables the estate or heirs to utilize split interest trusts and make outright donations of items with clouded title, thereby rationalizing and enhancing liquidity.

In conclusion, the valuation and management of art and collectible assets during estate administration can be complex due to the unique aspects of such holdings. Clarifying the title, utilizing an LLC for managing the collection, and considering potential tax advantages significantly aid in maximizing the value of these assets. 

Understanding these elements, along with knowledge of the latest USPAP guidelines, is crucial for ensuring a transparent and efficient estate process.