Permanent Estate Tax Repeal May Be Boon to Private Art Collectors

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By Allyson Versprille

Permanent estate tax repeal would allow private art collectors to hold onto their artwork longer, giving them more time to reap its full value, attorneys told Bloomberg BNA.

Art is an illiquid asset. When a person dies with a substantial collection, his or her estate may have to sell the artwork quickly in an estate sale to raise cash to pay the current 40 percent estate tax, said Malcolm S. Taub, a partner and co-chair of Davidoff Hutcher & Citron LLP’s Art and Estates Law practice group.

“If you have a collection that hasn’t been public and hasn’t been shown in museums and hasn’t been written about, then it takes time to develop the quality of the art or the value of the art, and that is absolutely very difficult to do within a nine-month period of time,” Taub said, referring to the fact that estate tax returns are due to the Internal Revenue Service nine months after a decedent’s death.

If families could keep the art in their collections longer, they would have more time to enhance the art’s value and get a larger return, Taub said.

The recent Republican tax framework proposed repealing the estate and generation-skipping transfer taxes, though it didn’t explicitly say if repeal would be permanent.

‘Fire Sale’

Another problem is that when people hear “estate sale,” they’re looking for reduced prices, Taub said. “You might as well say fire sale.”

Large collections sold off at once in an estate sale may face the risk of a “blockage discount,” said Brad Dillon, a vice president and senior wealth planner in the New York office of Brown Brothers Harriman. A blockage discount reduces the value of a group of artworks by a single artist to account for the depreciation risks of releasing a large volume of works into the market all at once.

Under these circumstances, a large collection in an estate sale “may not get as high of a price as it would have in the normal market if a single piece of that collection was sold over time,” Dillon said.

In the absence of an estate tax, collectors could see their artwork increase in value by single- or even double-digit percentage points, he said.

High-Profile Scenario

Even high-profile collections may face lower-than-expected returns as a result of the estate tax, Taub said.

At the end of 2015 into the beginning of 2016, Sotheby’s held four auctions to sell off the personal art collection of A. Alfred Taubman, the shopping-mall tycoon who died in April 2015. The collection included artwork by Pablo Picasso, Albrecht Dürer, and Raphael. The auction house said at the time that the proceeds would be used to settle estate tax obligations and to fund Taubman’s private foundation.

Even in that highly publicized scenario where the art was sold by a first-rate auction house, “the feeling was that it didn’t fetch as much as it could have if it was sold in a much more leisurely, time-extended manner,” Taub said.

Sotheby’s famously guaranteed the sale of the collection to Taubman’s heirs for just over $500 million. In its annual report for the fiscal year ended Dec. 31, 2016, Sotheby’s projected an approximately $3 million loss on the guarantee, recognized in the fourth quarter of 2015. The company also said it incurred direct costs of $6 million to promote and conduct the sale in the fourth quarter of 2015.

Donations to Museums

Today, some private collectors may choose to bequeath their art to charities, museums, or universities at death because they can get an estate tax charitable deduction.

The Republicans’ tax framework proposes retaining tax incentives for charitable contributions. But permanent elimination of the estate tax may reduce incentives for people to give artwork to museums and charitable foundations, Taub said.

That negative outcome may be mitigated, however, if estate tax repeal is combined with elimination of the basis step-up at death, which is likely, said Richard M. Horwood of Horwood Marcus & Berk Chartered. “If one door opens, another one closes,” he said.

The basis step-up is an income tax benefit under the existing system that allows a person who holds onto his or her assets until death to get the value of those assets readjusted to fair market value when a beneficiary inherits them. This reduces the amount of capital gains tax that heirs must pay on the inherited property if they sell it.

Carryover Basis

Congress would likely have to institute a carryover basis regime similar to the one that applied in 2010 when the estate tax was temporarily repealed as a result of the 2001 Bush tax cuts, Horwood said.

A carryover basis regime may encourage charitable giving as a way to offset capital gains taxes, because beneficiaries would inherit the basis—or original purchase price—of property transferred from the decedent, he said. The value of inherited artwork may grow significantly from its original purchase price, which can trigger a hefty tax bill if the beneficiary sells it.

The extent of an income tax charitable deduction associated with art donations varies based on several factors, including the type of charitable organization that receives the donation—public or private—and whether the use of the art is related to the organization’s charitable purpose.

A carryover basis regime may also encourage beneficiaries of artwork to use like-kind exchanges to defer capital gains taxes, Horwood said. In a like-kind exchange, taxpayers can postpone paying tax on the gain of a sale if the proceeds are reinvested in similar property. The Republican tax framework doesn’t mention changing this provision, Horwood said.

Temporary Versus Permanent

Art collectors and their families should be aware of the high likelihood that estate tax repeal isn’t permanent, Dillon said. It may be temporary if it’s passed through the budget reconciliation process, which imposes restrictions on a bill adding to the deficit after a decade.

Even if repeal is permanent, an estate tax could also “come back under a different administration or different Congress,” Dillon said. “We’re really trying to plan for all eventualities,” he said. “Even if it’s ‘permanently’ repealed, I think most planners and art collectors will still be nervous about it coming back.”

Many private art collectors deal with illiquidity in their estates by taking out life insurance policies that can be exorbitantly priced, Dillon said.

Those clients are hoping for permanent estate tax repeal so that they can stop paying the expensive premiums on their plans, Dillon said. But if they get rid of those policies and the tax is reinstated they would “have to pay even more exorbitant premiums.”

Horwood advised taxpayers with large art collections to take a wait-and-see approach to tax reform. “There’s no reason to rush into anything,” he said.

“There’s no door closing here, except on paying the estate tax,” he said.

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

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