Beth Smith
Executive Director
Morgan Stanley Advanced
Planning Director

Collectible art is a common nontraditional investment among ultra high net worth families and, in my experience, appears to be increasing in popularity. As you consider the disposition of your collection, you may decide to donate part, or all, of your collection to a charitable entity. So, what should you be thinking about if you are considering donating a work of art, whether during your life or as part of your estate?

While clients may give art to whomever they wish, museums are a top choice because they want the artwork and, as a bonus, a gift of art to a museum likely will produce a tax benefit.

While wealthy clients donate art to a wide variety of charitable entities, museums are a particularly attractive choice for three reasons:

First, gifts to public charities receive the highest income tax deduction for art- work, and most museums are treated as public charities. That helps to maximize the amount that donors can deduct from their income taxes over their lifetimes for gifts of art.

Second, how the beneficiary uses the gift may also affect the amount of the charitable income tax deduction. If the gift of artwork is used in a way that is related to the charitable organization’s mission, then pursuant to the “related use rule,” the income tax deduction is based on the fair market value of the donated artwork (rather than its cost basis). This generally means a higher income tax deduction for the donor.

Third, in many cases, a well-chosen museum can be a better steward of the art piece than family members. This qualitative, nontax reason is often an important driver of gifts to museums.

Use an art advisor

Giving away art should be simple, right? Well, it’s not as easy as it may seem. Most major museums will not accept a work of art unless it fills a gap in its permanent collection or otherwise advances a current institutional goal. When the proposed gift is of an entire collection, as opposed to a discrete piece, the likelihood of rejection is even higher. To address this challenge, collectors should consult with an art advisor about the needs and goals of prospective done organizations to make it more likely that the gift will be accepted. As with other asset classes, the art market is cyclical and particular artists and genres may fall in and out of favor. Art advisors can be helpful in determining the most beneficial timing of gifts and can also help to align the client’s vision with the vision of the institution, particularly if the client hopes to see her or his art displayed on a long-term basis. Most donors don’t want a museum to sell recently donated art or consign it to storage.

Where should Clients donate?

Most people want to give art where it will be seen and appreciated; however, many mistakenly believe their donated works of art will become a permanent piece in the museum of their choice. They assume that, once accepted, their art will be displayed and promoted, or that their art will become part of the museum’s permanent collection and never deaccessioned. These assumptions may prove false. Due to decreased funding, limited storage space and highly selective art acceptance committees, major museums have limited their acceptance of works of art. Make sure you understand the long-term plan for your art and create a realistic strategy with le- gal counsel and an art advisor. In many cases, it may be best not to focus on the largest and most famous museums. Less notable organizations often have more space and additional flexibility. Regardless of where you decide to donate your art, it is extremely important to make the gift pursuant to a written agreement that builds in flexibility, and provides clear terms that could be enforceable at a later date. An attorney or an independent art professional can help negotiate and document the transaction.

IRS regulations state that a gift of property (other than cash or market- able securities) that has a value exceeding $5,000 requires that the donor obtain a qualified appraisal (dated within 60 days of the gift), and attach the appraisal summary to the income tax return. The appraisal will include such information as a detailed description of the property, its condition, the expected date of gift and the method of valuation.

The appraised value of the art, together with its quality, size, condition, rarity, historical importance, subject matter and style, will help to determine what charitable organization might be the best potential recipient.

Getting A Charitable Contribution Deduction

In order to obtain a charitable contribution deduction equal to the fair market value of the work of art, the work must be donated to a public charity or private operating foundation, and the donor must anticipate that the charity’s use of the work will be “related” to its exempt purpose.

For example, a gift of a painting to a museum would clearly be a related-use gift. A gift of a work of art to a school with a museum, which uses it for art instruction, should also be a related- use gift. However, if the work of art is contributed, for example, to the local SPCA, which in turn just plans to sell the art, the amount of the deduction would be limited to basis, because the gift would not be related to the organization’s exempt purpose. It is important that you understand the future use of the artwork, because the nuances can affect the amount of the income tax deduction.

It’s also important to understand what type of property the artwork will be deemed to be for tax purposes. Generally, a work of art held by a collector is capital gain property and qualifies for deductibility at full fair market value, if it meets the related-use rule discussed above. The contribution is deductible up to 30% of adjusted gross income (AGI), with any excess contribution deductible over the following five years (limited to 30% of AGI) until exhausted. However, the art will be deemed to be ordinary income property, if (i) the donor created it, (ii) the donor received it as a gift from the creator, (iii) it is held as inventory by a dealer, or (iv) its sale would generate short-term capital gain because it was held for one year or less. If it is ordinary income property, the deduction is for cost basis only, up to a maximum of 50% of AGI.

Donations of Art at Death

For testamentary gifts of art, the estate tax charitable deduction is unlimited, and the related-use rule does not apply. This may produce a larger tax benefit than a lifetime gift of art. In addition to the estate tax savings, it also removes an illiquid, difficult-to-value and often unwanted (from the heirs’ perspective) asset from the estate.

It’s important for collectors to plan properly for both lifetime and testamentary dispositions of art collections. Seek the assistance of a qualified art advisor and legal counsel, so that you are better prepared to find the right recipient and structure your gift wisely, creating a more successful and satisfying experience.

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