What should donors be thinking about when making a donation of a piece of art, during life or at death?
Art is a common non-traditional UHNW investment. As you consider how to plan for the disposition of your art, a gift to a charitable entity will often come to mind. So what should donors be thinking about when making a donation of a piece of art, during life or at death?
While you may gift your art to whomever you wish, museums are often a top choice. In addition, a gift of art to a museum may offer a tax benefit. There are three common misconceptions people often run into when donating art to museums:
- The amount of a donor’s charitable income tax deduction for a lifetime gift of art is always the same. In fact, it depends in part on the recipient charity’s status. Gifts to public charities have the lowest limitation on deduction for artwork, and most museums are treated as public charities.
- How the museum uses the gift has no impact on the amount of a donor’s charitable income tax deduction. In reality, however, if the gift of artwork is used in a way that is related to the organization’s mission, then pursuant to the “related use rule,” the income tax deduction is generally 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.
- It is typically beneficial to keep the art in the family. Surprisingly, in many families the right museum can be a much more effective and impactful steward of the gift, than other family members.
Here are a few tips for addressing these misconceptions.
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 an entire collection, instead of an individual 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 organizations to improve their chances of acceptance. 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.
Most people want to give art where it will be seen and appreciated; however, many mistakenly believe their donated works of art will automatically become a permanent piece in the museum of their choice. Unfortunately, due to decreased funding, limited storage space, and highly selective art acceptance committees, major museums have become increasingly scrupulous. For most people, it may be best not to focus on the largest and most famous museums as less notable organizations often have more space and additional flexibility.
Regardless, it is wise to consult an attorney or independent art professional to help negotiate and document the transaction. A written agreement provides clear terms that will be enforceable at a later date.
IRS regulations state that a gift of property (other than cash or marketable securities) that has a value exceeding $5,000 requires that the beneficiary obtain a qualified appraisal, no earlier than 60 days before the gift is made and no later than the due date of the tax return on which the deduction is claimed. IRS Publication 561 (“Determining the Value of Donated Property”) lists 11 points of information that each appraisal must contain including size, subject matter, medium, name of artist, and date of creation. In addition, a donor must also complete IRS Form 8283 if the amount of the deduction for non-cash gifts is more than $500. The donor is also required to maintain records of the contribution, as specified in IRS regulations.
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. In some instances, a charitable contribution of artwork can lead to income recapture if the donation to the charitable organization exceeds $5,000 and the organization disposes of the artwork within three years of the donation (Sec. 170(e)(7)). The donor can avoid this harsh penalty by requesting a specific written certification from the recipient organization, under penalties of perjury, certifying that their use of the artwork was substantial and 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, may 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 likely be limited to its cost basis, because the gift would not be related to the organization’s exempt purpose. It is important to understand the intended future use of your donated artwork, because the nuances can affect the amount of your 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”) for donations to a public charity, with any excess contribution deductible over the following five years (limited to 30% of AGI) until exhausted. However, the art is deemed 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 for donations to a public charity.
For testamentary gifts of art, the estate tax charitable deduction is unlimited and the related use rule does not apply, which 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. One exception to the IRS income tax charitable deduction rules on donating art is that artists who donate their own work – for sale, silent auction or exhibition – are allowed to deduct only the cost of materials used to create that particular piece of work, as opposed to the fair market value of the work.