A potential game changer for property taxes on art


IN LIFE, James A. Elkins Jr., a prominent Houston businessman and philanthropist, amassed a portfolio of art that was the envy of museums and collectors alike. He owned works by Pablo Picasso, Jackson Pollock, Jasper Johns, David Hockney, Willem de Kooning, and other great moderns.

In death, this collection of 35 million dollars is the envy of the tax authorities.

After Mr. Elkins died in 2006, his estate paid millions of dollars in art taxes. But the Internal Revenue Service said that was not enough and asked for an additional $ 9 million. Since then, they have been fighting in court.

The problem is how to value fine art for tax purposes – and the estate’s recent victory in an appeals court may help reshape the rules.

The case centers on an increasingly common movement among wealthy families with large collections of art.

During their lifetime, Mr. Elkins and his predecessor wife had given their three children partial shares of two groups of paintings and kept a piece for them. The goal, in part, was to lower the inheritance tax bill by donating shares of the paintings during his lifetime while still being able to keep the art on his walls.

At his death, he still had a 50% stake in three works by Pollock, Picasso and sculptor Henry Moore valued at $ 10.6 million and an approximate 73% stake in 61 other pieces of a worth $ 24.58 million. His children owned the other shares equally.

The tactic – partial ownership of an asset or group of assets – is typical of the transmission of private businesses or real estate. In such cases, the IRS typically allows rebates on assets when calculating inheritance taxes. For family businesses, the rebate is around 30 to 50 percent of fair market value. On real estate, it is 20 to 50 percent, according to Carsten Hoffmann, managing director of FMV Opinions, an appraisal firm.

The IRS does this because it recognizes that these assets may be difficult to sell to someone who is not a family member. And even if someone who was not a family member bought the shares, the price would likely be less than fair market value because the non-family minority interest would most likely have little say in the transaction.

But art was treated differently. Part of its value is that the owner can watch it. You cannot, after all, put a third of a Picasso on the walls of three people as you can share the profits of a business. To comply with timeshare rules, owners must take possession of a painting for an annual period equal to their share.

Over the years, the IRS has rarely granted a rebate for works of art shared between heirs. This has been the case even though it would be difficult for the heirs to sell their shares independently – and even assuming that is possible, a price cut would be necessary.

Another reason for the IRS’s reluctance is the museum factor. Many people donate percentages of a painting to a museum over several years so that the deduction matches their income. While the ultimate goal is to donate 100 percent of the painting to the museum, people might be dissuaded from donating art over time if the IRS downgrades the value of charitable donations, said Ramsay Slugg, chief executive of the financial company US Trust and author of “The Practical Planning Handbook for Art Collectors and Their Advisors.

In the Elkins case, art is the only asset the IRS is challenging. (The handover of the racehorses, which Mr. Elkins also owned, is apparently easier to do.) After presenting exhaustive data on the prices and the rationale for the handing over of each part, the estate opted for a discount of 44.75% for the entire collection.

But the IRS said no rebates should apply to s. The estate therefore went to court. He first got less than he wanted. While the Tax Court disagreed with the IRS ruling against a rebate, he ruled that the rebate used by Elkins’ estate was too high. The court awarded a 10 percent reduction.

The estate escalated the fight, appealing the ruling to the United States Court of Appeals for the Fifth Circuit. Last month, this tribunal overturned the remission decision and criticized the IRS for failing to provide any evidence to support its position. He also gave the estate a refund of $ 14 million plus interest, based on part discounts ranging from 50 to 80 percent.

Credit…Dmitri Kessel / The LIFE Picture Collection, via Getty Images

The decision may have created a model for other wealthy families.

“I got calls from estate planning attorneys who told me they were celebrating in the dining room when this decision came out,” Hoffman said. “It’s a change of deal.”

Mr. Hoffman was the appraiser in an earlier case involving discounted works of art, Stone v. US, which focused on a half-interest in 19 paintings, including two by H. Claude Pissarro. In 2009, the Ninth Circuit Court of Appeal upheld the 5% discount from a lower court, citing the lack of support prices from the art world.

This does not mean that it will be easy for other areas to get big discounts on works of art after the IRS.

On the one hand, the Elkins family had pockets deep enough to fund the effort. Mr. Elkins’ father founded a large law firm in Houston, and his wife’s family helped start Exxon Mobil. He himself had a successful banking career until the bank he ran, First City Bancorp, collapsed along with the oil companies it loaned to in the 1980s.

In the Stone case, the reimbursement of the 5% rebate was $ 53,932.60. It’s not a stupid change. But that’s hardly a godsend considering the associated legal bills.

“My genuine take is that this is a great result for taxpayers, but I don’t think it’s all clear,” said Diana Wierbicki, partner and head of global art practice at Withers Bergman, a firm of lawyers. “The IRS dropped the ball. The IRS has pushed this idea that you should get zero.

Eric Smith, an IRS spokesperson, declined to comment.

Mr Slugg said there were practical ramifications of the decision, namely that more families could start dividing their art collections to get inheritance tax relief. But it is not necessarily practical to follow the letter of the law. These works must be moved between the different owners so that each has possession of them for a period of time proportional to their participation.

“The most common time damage occurs is when a painting is moved,” he said. “There are all kinds of fractional interest considerations. It’s great for wealth transfers but not in practical reality.

He advised clients with collections to put the art – or their current fractional ownership interests in the art – into a family limited partnership or limited liability company that would then own it. One drawback is the additional costs associated with setting up and administering these vehicles.

Another option to stay in compliance with the law is for the owner to give the art to the heirs and re-let it. Art can still be hung on the wall, while heirs receive a percentage of the value each year as owners. Such arrangements are common in areas like real estate where a person can give a townhouse to their children and then rent it out for a number of years.

For art, it is a more recent concept. Paul Provost, vice president of Christie’s, said the auction house had developed a methodology for charging rent for art. He said the starting point was the rental values ​​of works of art valued at less than $ 20,000. Such art, he noted, is often rented out by home stagers.

Christie’s takes that and extrapolates the value up; it then proceeds to a qualitative assessment of art. “A lot of customers have just come up with their own number,” he said.

Whatever strategy you choose, valuing art shares is not an exact science. Mark L. Mitchell, director of appraisal services at Peterson Sullivan and one of the three expert appraisers in the Elkins case, said the passion of collectors was what made it so difficult.

“The art could be owned by someone who doesn’t care about generating a return on their investment but still derives enormous non-cash value from it,” Mitchell said. “Fractional interest lowers the non-cash part of it so much that people just don’t want to.”

Or in other words, other assets are less emotional to share. “You really don’t get any non-cash return from owning a stock, bond, or commercial real estate,” he said.

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