A collection can be very special and unique to the individual. Passions can range from cars, wine, art, comic books and figurines. These works of “art” often evokes memories for the collector, or the family, and the legacy it leaves behind. Eventually, collectors need to plan for how they want to pass on their beloved collection.
The first decision is whether the transfer will occur while the collector is alive or at passing. The next decision is if the collection will be gifted to a charitable organization or passed on to heirs. Each of these choices has its own consequences. For example, if a collector gifts a collectible to his/her children the positive impact is the asset is out the collector’s estate. However, the original basis carries over and no step-up in basis is received; the gift reduces the collector’s lifetime gift exemption. On the contrary if the collector waits and transfers the collectible to his/her children upon passing the positive impact is the basis step-up. The risk is the estate could be subject to estate taxes and if the estate is illiquid then a sale is forced. In both scenarios the children are free to sell the collection and if this is not what is intended then the collector should have this conversation with his/her children or state the wish via the trust document.

The Pain of Selling

Sometimes the emotional attachment to a piece prevents a collector from selling. Other times the tax bill is enough to deter a sale. Any appreciation that is recognized in selling a collectible item is taxed at either the federal long-term capital gains rate of 28% or ordinary income rates, which can be as high as 39.6%. For example, let’s assume a collector has a painting worth $100,000 (purchased 20 years ago for $10). When the painting is sold the gain may be subject to 28% federal capital gains tax, 3.8% Medicare surtax, and state capital gains tax. If a piece of art has grown significantly in value, the collector may consider gifting to charity.

Gifting to Charity

Most donors will gift highly-appreciated assets with large capital gains to a charitable entity. In our previous painting example, the donor could directly gift the painting and, if the charity eventually sells the item, zero capital gains tax is due. According to a recent report from the IRS, a large portion of Americans fund their charitable goals with non-cash gifts. In 2012, donations of art and collectibles increased by one-third to $1.18 billion. This amount may be higher since it does not include figures from split interest trusts.

The benefit of gifting the right type of asset can be enormous. The amount of deduction received by the donor and percentage AGI (adjusted growth income) limitation is determined by several factors. The main factors are: if the asset is considered capital gain property or ordinary income property; whether the gift is to a public charity or a private foundation; and how the work of art will be used by the charitable organization.

Gifting non-cash assets is a complex area and one strategy does not fit all. When it comes to collectibles, there are several options, such as charitable remainder trusts, lending foundations or leasebacks. It is vital to work with an experienced professional to determine the optimal strategy for each individual.

Primer on Tax and Other Issues Relevant to Art Collectors and Their Advisors, Paul N. Frimmer
IRS Statistics of Income Individual Noncash Contributions, 2012