By Elizabeth Summers*
For better or for worse, the world cares how much collectors pay for art. A record price realized at auction or in a “private” sale can create headlines in both art world publications and the national press. The final value of a collection, however, is determined only upon the collector’s death, when the personal representative of the estate assigns a value to the art for purposes of the federal estate tax. Issues surrounding the valuation of art have generated extensive and energetic litigation in the U.S. Tax Court and, by extension, considerable interest among estate planning attorneys.
General Rules of Estate Tax Valuation
The value of a decedent’s gross estate is determined by calculating the value of all property the decedent owned at the time of his or her death, wherever such property is situated. (IRC Section 2031) Under IRS regulations regarding valuation for estate tax purposes, the value of every item of property includible in a decedent’s gross estate is its fair market value at the time of the decedent’s death. (T.R. Section 20.2031-1(b)) The IRS defines “fair market value” as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts. With unique objects like individual works of art, the determination of a “fair market value” may be difficult. Fortunately, the IRS has provided additional guidance. Special rules apply to tangible personal property “having marked artistic or intrinsic value” of a value in excess of $3,000. Items that fall into this category must be formally appraised, and the appraiser must be competent in the specific subject matter of the appraisal. The appraisal of a painting of “artistic value” must include a description of the size and subject of the painting and the name of the artist. The appraisal must be filed with the estate tax return, along with a written statement by the executor containing a declaration that, under penalty of perjury, the appraisal is complete and accurate, and the appraiser both qualified and disinterested.
Valuation of Works of Art
While relatively minimal guidance exists in the Internal Revenue Code and Treasury Regulations specific to the valuation of art, subsequent IRS publications have created further special requirements for works of art that have been appraised at $50,000 or more and are transferred at death. The IRS now provides a procedure through which the executor of an estate may request a “Statement of Value.” The Statement of Value is effectively a pre-approved appraised value, issued by the IRS, that the executor may rely on to substantiate the value of a work of art for purposes of the estate tax.
For the purpose of the Statement of Value requirements, the IRS defines “art” as “paintings, sculpture, watercolors, prints, drawings, ceramics, antique furniture, decorative arts, textiles, carpets, silver, rare manuscripts, historical memorabilia, and other similar objects.” The executor must request a Statement of Value for an item prior to filing the federal estate tax return that first reports the transfer of the art work. The request must include the following: a copy of the appraisal; a description of the work; the appraised fair market value; the cost, date and manner of acquisition; the date of death; and the location of the IRS District Office with jurisdiction over the estate tax return. The current fee for a Statement of Value is $5,700 for one to three items, and $290 for each additional item.
An appraisal submitted for purposes of securing a Statement of Value must contain, among other information, a detailed description of the work, a professional photograph, the specific basis for the valuation, and a statement that the appraisal was prepared for estate tax purposes. The appraiser must prepare, sign and date the appraisal and sign a statement attesting to his or her competency and expertise. The appraisal must be prepared within 60 days of the valuation date, and the executor must sign the request for the Statement of Value under penalty of perjury. While the Statement of Value procedure constitutes a kind of insurance against challenge for the valuation of an asset that might otherwise be subject to significant scrutiny, it can be time-consuming and expensive.
All returns selected for evaluation or requests for a Statement of Value that include an artwork with a claimed value in excess of $50,000 will be submitted to the IRS’s Art Appraisal Services department for possible review by the Commissioner’s Art Advisory Panel. The IRS established the Art Advisory Panel in 1968 for the purpose of assisting the IRS in evaluating appraisals of art. The Panel is composed of renowned curators, dealers and art historians from across the United States. In 2015, the most recent year for which a report is available, the Art Advisory Panel reviewed 446 appraisals of artworks, representing a total value of almost $650 million. Of these appraisals, the Panel recommended adjustments to the appraised value of the property approximately 65% of the time. While the IRS is not technically bound by the Panel’s recommendation, in practice, its opinion is generally decisive.
Because the outcome of an appraisal can dramatically affect the amount of estate tax the collector’s estate owes, it should come as no surprise that art appraisal issues have been extensively litigated in the Tax Court over the past decade. Following are some recent cases of interest.
Effect of Economic Forces in the Estate of Bernice Newberger v. Comm’r, T.C. Memo. 2015-246 (2015).
In some cases, the appraised value of a work may not be the best indicator of value and in such instances the Tax Court may also consider relevant sales and the effects of larger economic forces upon the art market. The variations in market and appraised value are well illustrated by the ruling by the Tax Court reached in regards to the Estate of Bernice Newberger . Upon Bernice Newberger’s death in July of 2009, her art collection included Pablo Picasso’s Tete de Femme (Jacqueline), an untitled work by Robert Motherwell, and Jean Dubuffet’s Element Bleu XV. In early 2010, Christie’s appraised the Picasso at $5 million. Sotheby’s appraised the Motherwell at $450,000 and the Dubuffet at $500,000. The Picasso sold in an auction at Christie’s on February 2, 2010, for over $12 million. The estate listed the appraised values on the estate tax return that it filed in October of 2010. The return made no reference to the 2010 February sales price of the Picasso. The estate continued to hold the Motherwell and Dubuffet.
The IRS issued a notice of deficiency stating that the Picasso, the Motherwell and the Dubuffet had values of $13 million, $1.5 million and $750,000, respectively. The IRS based its adjusted valuation on the February 2010 sales price of the Picasso, the sale of a comparable work by Motherwell for $1.4 million in November of 2010, and the sale of a comparable work by Dubuffet for $825,000 in November of 2007. The estate promptly appealed, asking the Tax Court to honor the original $5 million valuation because the Christie’s sale was “a fluke,” and arguing that the comparable sales prices for the Motherwell and the DuBuffet failed to take into account the effects of the global recession of 2008-2009.
In a remarkably nuanced decision, the Court held for the IRS in valuing the Picasso at $10 million, which the IRS expert had arrived at by adjusting the sales price to account for July 2009 market conditions. However, the Court held for the estate regarding the Motherwell and Dubuffet works, finding that the estate’s experts had properly taken into account the depressing effects of the global recession on the art market at the time of Ms. Newberger’s death. The Court made specific reference to the IRS expert’s “inexplicable” valuation of the estate’s Motherwell at a price above the sales price for the comparable work, which was sold in November of 2010, after the art market recovered.
Fractional Interests in the Estate of Elkins v. Comm’r, 767 F.3d 445 (5th Cir. 2014)
The ownership of a work of art can be divided into a number of fractional interests. While fractional interests allow the owner to discount the value of his or her property for lack of marketability and control, they can create significant hurdles for the appraiser.
James Elkins built an impressive art collection over his lifetime, including works by Pablo Picasso, Jackson Pollock, Jasper Johns, Cy Twombly, and David Hockney. By the time of his death, James Elkins owned fractional interests in 64 pieces of artwork. Specifically, Elkins owned a 73.055% interest in 61 of the works, subject to a restrictive co-tenant’s agreement with his children (the holders of the remaining fractional interests), and a 50% interest in a grantor-retained income trust (“GRIT”) that owned 3 works. Following Elkins’ death in February of 2006, his executor valued his 73.055% interest in the 61 works owned in conjunction with his children at approximately $9.5 million, and his 50% interest in the GRIT at approximately $2.6 million. To reach this value, the executor commissioned an appraisal from Sotheby’s, determined Elkins’ pro-rata share of the value of the appraised works, and applied a 44% discount to the pro-rated appraised value for lack of marketability and control. The IRS issued a notice of deficiency valuing the estate’s 73.055% interest at approximately $18.4 million and the 50% interest in the GRIT at $5.3 million. See Estate of Elkins v. Comm’r, 140 T.C. 86 (2013).
The Tax Court disregarded the restrictions in the co-tenancy agreement between Elkins and his children and, with it, the estate’s 40% discount. The discount was reduced to 10% to account for the uncertainties a hypothetical buyer would face in determining a resale value in light of Elkins’ children’s continuing interests in the works. Understandably, the estate appealed.
On appeal, the Fifth Circuit Court of Appeals reversed the Tax Court ruling and held that indeed the estate was entitled to a higher discount for the fractional ownership.
Conflicts of Interest in Estate of Kollsman v. Comm’r, T.C. Memo. 2017-40.
In evaluating an appraisal, the IRS will also scrutinize the motivations of the appraiser as it did in the review of the valuations submitted for the Estate of Kollsman. Upon her death, Eva Franzen Kollsman owned two old master paintings: Maypole by Pieter Brueghel the Younger, and Orpheus attributed to Jan Brueghel the Elder, Jan Brueghel the Younger, or a Brueghel studio. A Sotheby’s specialist sent a brief letter to the executor of Kollsman’s estate appraising Maypole at $500,000 and Orpheus at $100,000, which values the estate included on Kollsman’s federal estate tax return. The same specialist also sent another letter proposing that the estate grant Sotheby’s an exclusive right to auction both works, and stated an estimated value at auction of $600,000-800,000 for Maypole and $100,000-150,000 for Orpheus. The estate accepted Sotheby’s proposal. The IRS issued a notice of deficiency, finally asserting a value of $2.1 million for Maypole and $500,000 for Orpheus.
At trial, the Court essentially disregarded the Sotheby’s appraisal, believing the appraiser gave a low estimate in order to reduce the estate’s tax burden and “curry favor” with the executor for the purpose of securing the right to auction the works. The Court accepted the IRS’s valuations, applying only a 5% discount for the risks associated with cleaning the paintings and an additional 20% discount for Orpheus due to the work’s generally poor condition and the uncertainty of its attribution.
The manner of disposition of the collection may also be relevant for purposes of valuation. Some estates include a “blockage discount” in the calculation of the value of a collection. A blockage discount accounts for the difference in the overall value realized if a number of works by a single artist are liquidated at once, as opposed to being sold off one by one. Selling a large “block” of works risks flooding the market and devaluing all of the artist’s work. Blockage discounts have been utilized in a number of collectors’ and artists’ estates, including those of Georgia O’Keeffe and Andy Warhol.
The IRS contested the application of a blockage discount to the appraisal of certain works of art owned by the estate of Lisa de Kooning, the daughter and sole heir of the abstract expressionist Willem de Kooning. Upon de Kooning’s death in 2013, Christie’s valued her collection of her father’s paintings and sculptures at $231 million. The estate commissioned two experts to calculate the amount for a blockage discount for the collection. The experts determined that the appropriate discount would be 60% for the paintings and 85% for the sculptures, and consequently valued the entire collection at a total of approximately $100 million. The estate submitted a request for a Statement of Value reflecting this amount.
After consulting the Art Advisory Panel, who advised that the value of de Kooning’s works would only increase over time, the IRS rejected the blockage discount and issued a Statement of Value of approximately $255 million. This figure included a 50% discount for sculptures valued at over $100,000. Undeterred, the estate challenged the Statement of Value in its return and submitted additional information regarding the blockage discount. The IRS promptly disallowed the sculpture discount and, without making any adjustment to the Statement of Value, increased its value of the collection by $60 million to approximately $315 million. In February of 2017, the estate filed a case with the Tax Court to contest the IRS’s new position and the resulting $92 million tax bill. As of the date of this article, the case remains pending and the result shall be of keen interest to both estate planners and art law enthusiasts.
Despite the guidance provided by the IRS and relevant case law, the appraisal of art for estate tax purposes remains more of an art than a science. The valuation of artwork is intensely fact-specific, subject to a short time horizon, and dependent on the state of the art market. For those in New York City on November 10, 2017, the upcoming Art Law Day organized by the Appraisers Association of America might be of some interest.
- IRC Section 2031 (https://www.law.cornell.edu/uscode/text/26/2031)
- T.R. Section 20.2031-1(b) (https://www.law.cornell.edu/cfr/text/26/20.2031-1)
- T.R. Section 20.2031-6(b). (https://www.law.cornell.edu/cfr/text/26/20.2031-6)
- T.R. Section 20.2031-6(d).
- Rev. Proc. 96-15. (https://www.irs.gov/pub/irs-drop/rp96-15.pdf)
- Rev. Proc. 2017-01. (https://www.irs.gov/irb/2017-01_IRB/ar07.html)
- The Art Advisory Panel of the Commissioner of Internal Revenue, Annual Summary Report for Fiscal Year 2015 (Closed Meeting Activity). (https://www.irs.gov/pub/irs-utl/art_adv_panel_annual_summary_report_fy15.pdf)
- Ralph E. Lerner & Judith Bresler, Art Law: The Guide for Collectors, Investors, Dealers, & Artists (4th ed. 2012) (https://www.amazon.com/Art-Law-Collectors-Investors-Dealers/dp/1402418884)
- Estate of Newberger v. Comm’r, T.C. Memo. 2015-246. (https://www.ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=10646)
- Estate of Kollsman v. Comm’r, T.C. Memo. 2017-40. (http://www.ustaxcourt.gov/USTCInOP/OpinionViewer.aspx?ID=11129)
- Estate of Georgia T. O’Keeffe, TC Memo 1992-210. (http://www.leagle.com/decision/1992276263hbtcm2699_12553/ESTATE%20OF%20O’KEEFEE%20v.%20COMMISSIONER)
- In the Matter of the Estate of Andy Warhol, Deceased (N.Y. Surr. Ct. Apr. 18, 1994), rev’d, 629 N.Y.S.2d 621 (Surr. Ct. 1995), aff’d in part and modified in part, 637 N.Y.S.2d 708 (App. Div. 1996). (http://www.leagle.com/decision/1995891165Misc2d726_1776/MATTER%20OF%20WARHOL)
- Jimmy Hoover, De Kooning Estate Battles $92M Tax Bill Over His Artwork, Law360, March 6, 2017. (https://www.law360.com/articles/898666/de-kooning-estate-battles-92m-tax-bill-over-his-artwork)
*About the Author: Elizabeth A. Summers is a Trusts and Estates Associate with a firm in Minneapolis, Minnesota, where she specializes in wealth transfer planning for high net worth individuals and families.
Disclaimer: This article is intended for educational purposes only and is not meant to provide legal advice. Any views or opinions made in the linked article belong to the author alone. Readers are not meant to act or rely upon the information in this article and should consult a licensed attorney regarding their specific situation.