Artwork can be really valuable. For example the FBI and the Isabella Stewart Gardner Museum are offering a $5,000,000 reward for anybody who can help them find the paintings stolen from the museum 23 years ago. The 13 artworks are worth on the order of half a billion dollars. Thus, it is hardly surprising that artwork will be a contentious matter in estate tax cases. If a family wants to hold on to artwork that has been collected over a lifetime, there can be a significant liquidity problem for the estate. Valuation discounts can help, but based on the recent Tax Court decision in the Estate of James Elkins, perhaps not as much as some might hope.
James Elkins and his wife Margaret, who predeceased him, had built a significant art collection. Included in the 64 works that were valued in the case were a drawing by Pablo Picasso and a Jackson Pollock painting. The whole list is in the appendix to the case. I also recognized the name of Paul Cezanne on the list. As for the rest of them. Well, dammit Jim, I’m a tax blogger not an art critic. I figure Jasper Johns must be somebody since his Figure 4, 1967 was worth $8,000,000. You can get a poster of Jasper Johns Figure 3 on Amazon for $18.81. Go figure.
The Elkins had done some significant planning around their artwork. It was held under co-tenancy agreements which were placed in Grantor Retained Income Trusts (GRITs). Mrs. Elkins did not outlive one of her GRITs, so some of her interests ended up with Mr. Elkins. He disclaimed a portion of them to use up her estates unified credit. In the end his estate had a 50% interest in three of the most valuable works and a 73.055% interest in the other 61. The fair market value of the paintings was not an issue in the case. The issue was valuation discounts.
The IRS had a pretty straight forward approach. The Jackson Pollock, for example, was worth $6,000,000. 50% of $6,000,000 is $3,000,000. The estate argued that it is more complicated than that. You might get $6,000,000 for selling the painting, but that does not mean that you will get $3,000,000 for selling a 50% undivided interest in the painting, if the other co-owners are not interested in selling. One of the estate’s experts put it this way:
Mr. Nash summarizes the “key factors” making decedent’s fractional interests in the art “unappealing” to potential buyers as follows: (1) the inability to sell the art at auction houses, (2) the lack of exclusive possession and the inability to force a sale of the art without litigation against the Elkins children as coowners, (3) possible litigation involving time of possession and proper care, storage or transportation of the art, and (4) the difficulty or impossibility of insuring the purchased interest or using it as collateral for a loan. Nonetheless, he concludes that speculators “would be willing to purchase * * * interests if appropriately discounted.”
The discount was for lack of control and marketability and came to 44.75%. The IRS argued for no discount at all. They had two experts testify. One was an art expert, who indicated that there really is not much of a market for fractional interests in works of arts. The other was a New York attorney who devotes himself to legal matters concerning art. He testified that the Cotenant’s agreement was not comparable to similar arrangements entered into at arms length.
If it had been King Solomon sitting in as Tax Court judge, he might have suggested that the Elkins children slice the artworks up into pro-rata pieces and then see how much they are worth. The actual Tax Court came up with an interesting approach. The theory for the very significant discount was based on the risk that a hypothetical speculative buyer would be taking given that the Elkins did not want the artwork to be sold. The Court hypothesized that hypothetical buyers might have considered that the Elkins would get sick of the amount of schlepping that was involved in the co-tenancy arrangement and that the Elkins would be motivated to buy them out and could afford to do so. With that theory, the Tax Court allowed a 10% discount.
I asked my friend, attorney Matthew Erskine, who has a boutique practice focusing on unique assets. Matt’s office is right near the Worcester Art Museum, where for fourteen bucks you will probably be able to see a Cezanne, a Picasso and a Pollock although maybe not a Jasper Johns. Here is Matt thinks about the case:
In sum, The Estate of Elkins has three lessons for anyone who owns or advises owners of significant collections of artwork.
- Valuation discounting can work with artwork,
- Just plugging artwork into a discounting plan based on lack of marketability and lack if transferability will only generate a modest discount, and
- The safest route for valuation discounting is to have specialized split interest trusts and other discounting methods crafted specifically for artwork, so that the valuation issue is old and cold by the time the estate tax return is filed.
You can follow me on twitter @peterreillycpa.
Originally published on Forbes.com Mar 20th, 2013