2017 was a big year in the art world. A Saudi prince bought Leonardo da Vinci’s Salvator Mundi for $450 million. And a painting by Jean-Michel Basquiat, which was bought by a Japanese collector for over $110 million, bumped Andy Warhol from the top spot on the list of most expensive American artists. It will be hard for 2018 to top those eye-popping deals, but the year is young, so you never know! What we do know is that art collections need to be factored into estate plans if one wants to avoid making some big tax mistakes.
When dealing with a valuable collection of anything, special estate planning tactics should be employed to ensure the collection ends up where the collector wants it to, and to minimize the collector’s estate tax bill. Often, the best way for a collector to make sure these goals are accomplished is to sell or gift the art to someone else while maintaining physical possession of the collection.
Irrevocable trusts are a common estate planning tool in the property world, but they are just starting to be used for art. Art collectors are using irrevocable trusts to transfer ownership of their art out of their estate, then leasing it back so they can enjoy it in their homes while they are still alive. This lease-back strategy is commonly done with houses and apartments, so it is kind of a surprise that it has taken this long for the art world to catch on.
First, an irrevocable trust is set up by the collector. An irrevocable trust is an entity designed to be completely independent legal entity from the trust creator. Property that is put into an irrevocable trust no longer belongs to the trust’s creator, it belongs to the trust. However, the trust creator can serve as a trustee, and obviously the creator has a say in how the trust is designed to function. This takes the value of the art out of the collector’s taxable estate.
But that is not the only tax benefit of setting up an irrevocable trust. When the ownership of the art is transferred to the trust it is typically done as a gift. If the art is appraised for more than $14,000 at the time of the transfer, the collector will have to count the value of the art toward their annual gift-tax and estate-tax exemption or pay a tax on the gift. But in either case the art gets an important set up in basis that will be useful when the art is gifted or sold in the future. Assuming the art appreciates in value before it is transferred, the estate will have dodged a bigger tax bill.
Although the owner of the art changes, the pieces themselves don’t have to go anywhere. The collector can lease the pieces back from the trust by paying the trust a fair rental fee for the use of the art.
Documents related to the trust’s creation and the lease-back of any art must be carefully maintained and preserved. Art collectors should also take pains to document their collection as thoroughly as possible. Keep records of sales, certificates of authenticity, insurance records, and whatever else you can think of all together in one place. This information can increase the value of a piece, particularly if the records go all the way back to the transfer of the work from the artist to its first owner.