Collectors who have run out of space to store or display their
art at their homes inevitably confront the question of what to do
with their spare art. Collectors who are considering their estate
planning options might also question how their art figures into
their legacy. The options typically considered are to sell,
bequeath, or donate the art. This article describes a twist on the
third of these options: the donation of one's art to a museum
located on or near one's property, where the museum remains
largely controlled by the donor and might be thought of as an
extension of the donor's personal residence.
The choice between selling, bequeathing, or donating one's art
is sometimes influenced by tax considerations. To illustrate how
these considerations play out in real life, let's assume we
have a collector who paid $10 over the years to amass a collection
that today is valued at $100. Let's further assume that our
collector's net worth (excluding art) exceeds the threshold for
estate, gift, and generation-skipping taxes (i.e., for a married
couple, $10 million plus upward adjustments for inflation), so we
can be reasonably sure that a 40% tax will be levied on the fair
market value of any art that our collector bequeaths or gives to a
child.1 Our collector's options then appear to
be:
1. Sell the art for $100 and pay tax on the gain. At the federal level, the long-term capital gains tax rate of 28% plus a 3.8% surcharge for the so called "Medicare Tax" should apply, for a cumulative federal tax liability of $28.62 on the $90 of gain.2 This leaves the collector with a net return of $71.38. Assuming this $71.38 is eventually given or bequeathed to the collector's children, an additional 40% gift or estate tax would apply, leaving the collector's children with $42.83.
2. Give the art to her children and pay gift tax on the $100. This should trigger a gift tax liability of $40, which the donor would be required to pay. The children would receive the art with a "carryover basis," meaning that the children would be liable for a capital gains tax and Medicare Tax in the cumulative amount of $28.62 upon their sale of the art, as described in the preceding example. This results in a $40 liability for the donor and a transfer of $100 to $71.38 of value to the donor's children, depending on when and whether this capital gains tax is incurred.
3. Donate the art to a museum and claim a $100 charitable deduction. As we can assume the donor is taxable at the federal level at a 39.6% rate plus a 3.8% Medicare Tax, this deduction can result in a tax savings of as much as $43.40. Assuming this $43.30 of tax savings is eventually given or bequeathed to the collector's children, a 40% gift or estate tax would apply, leaving the collector's children with $26.04.
The examples above provide a rough illustration for the idea that,
after tax consequences are taken into account, selling and donating
art can yield roughly the same amount of financial value. This is
even more likely to be the case if state and local income taxes are
figured in, as these additional taxes increase the cost of selling
and, conversely, increase the savings to be had from donating
one's art to a museum.
For those collectors who would like to partake in the charitable
giving described above, but are reluctant to cede control over
their collections to a wholly unrelated museum, the idea of
establishing their own museum, with curators of their choosing,
might be a welcome one. Some of these collectors might even prefer
for such a museum to be located on or near their personal
residence, or for the museum to display its art within their homes.
The challenge for such an arrangement is in determining when a
donor's control over a museum renders the museum ineligible for
tax-exempt status. The applicable restriction is found in the
Treasury Regulations on charities, which state, in relevant part,
that "it is necessary for an organization to establish that it
is not organized or operated for the benefit of private interests
such as designated individuals, the creator or his family,
shareholders of the organization, or persons controlled, directly
or indirectly, by such private interests."3
There are only a handful of authorities describing how this
restriction is applied to a museum. Private Letter Ruling 8824001
appears to provide the most relevant guidance to persons
considering this strategy. The donors described in this ruling were
the sole contributors to a charity they had created, and the
charity displayed sculptures on the donors' property. Some of
the sculptures were viewable from the road, but most were obscured
by a privacy hedge or fence. The donors permitted members of the
public to tour the grounds upon request. The donors notified
various art museums and schools of the opportunity to tour the
grounds. The museum had almost 300 visitors per year.
The IRS ruled that this charity did not qualify for tax-exempt
status because it ran afoul of the prohibition against operating
for private interests. In arriving at this ruling, the IRS
noted:
1. The absence of a sign to advise passersby of the museum's location;
2. That most of the sculptures were clustered near the donors' home and pool, as opposed to more remote and less personal portions of the donors' grounds; and
3. The fact that no effort was made to advise the general public of the opportunity for touring the grounds.
From the foregoing, we may infer that a museum located on or near
one's property might qualify for tax-exempt status if it is
well publicized, physically separated from the donor's personal
living spaces, and is identified by signage.
Many donors, however, would be reluctant to create a museum on or
near their residence if in doing so they must advertise the
museum's location and invite members of the general public to
visit. This option is likely to appeal only to donors with estates
that are large enough to permit a remote portion to be set aside
for a museum, at a distance from their personal residence that is
sufficient to permit a measure of privacy. This appears to be the
price one has to pay to qualify for a charitable tax deduction for
art contributed to one's own museum, where the donor can manage
the charity and, to a degree, appear to retain the work by keeping
it close to home.
Footnotes
* IRS Circular 230 Disclosure: To ensure compliance with Treasury Department regulations, we inform you that any U.S. federal tax advice contained in this document (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the U.S. Internal Revenue Code of 1986, as amended (I.R.C.) or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.1 I.R.C. §§ 2001 and 2010.
2 The long-term capital gains tax rate from the sale of collectibles, including art, is 28%, whereas the long-term capital gains tax rate from the sale of stock is only 20%. I.R.C. § 1(h).
3 Treas. Reg. section 1.501(c)(3)-1(d)(1)(ii)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
