How a client is classified has a direct impact on the income tax treatment of her reported gains and losses and the deductibility of the expenses of maintaining her collection as reported on her personal income tax return. Failing to discuss the different classifications with a client or failing to recognize that a client may qualify for more favorable tax treatment as a dealer or investor can result in the loss of significant income tax savings to a client. 

There’s no statute of limitations on tax fraud, which includes estate tax fraud. If the existence of a collection isn’t properly reported on the Form 706, the IRS can pursue the decedent’s heirs for the payment of any unpaid taxes, interest thereon and penalties indefinitely. Failing to report and/or paying the estate taxes attributable to personal property may also affect issues of provenance. 

If a client’s collection must be sold in its entirety to pay the estate’s tax bill, it’s likely that the estate will only realize a fraction of the collection’s true value. There are numerous planning alternatives that can lessen the estate tax burden imposed on collectibles, including using the artwork to fund a client’s charitable intentions, strategic lifetime gifting and methods aimed at shifting highly appreciated (or soon to be highly appreciated) art outside of the taxable estate.

To identify the true value of art and collectible assets, clients should be encouraged or even mandated to obtain professional appraisals despite their upfront costs. Counsel clients on the many functions of appraisals in addition to those relating to estate and gift tax reporting (that is, establishing value for insurance purposes, establishing bidding parameters for assets at auction, obtaining loans with tangible personal property serving as collateral and planning for future gifts). 

Without a proper and organized inventory, a client can’t possibly plan for the distribution of her collection. A proper and organized inventory should include: (1) a system for indicating when an item is bought or sold and to or from whom, (2) records of loans and gifts to a person or entity, (3) records of appraisals and/or insurance, and (4) records of damages and losses. An up-to-date inventory will also enable a client to track the provenance of an item, which will be of utmost importance on any subsequent sale.

The provenance of any item is essential to determining its value. Evidence of an item’s history and proof of chain of title will help establish an item’s authenticity, resulting in the realization of the highest FMV for the item at the time of sale. It will also prevent a client from wasting money on items that are later determined to be inauthentic. A complete record of an item’s history and chain of title should include the item’s current location and whether there are any limitations on the ability to freely sell or move the item.

Accidents happen all the time. If a client doesn’t have the proper insurance in place, the results of even a small accident might prove to be economically devastating. A client’s collection can be insured: (1) as part of the contents of her home, (2) as separately scheduled items, or (3) through blanket coverage. Depending on the scope of a client’s collection, we often recommend the additional cost and hassle of procuring insurance on the collection by way of a separate schedule.

A collection may have significant meaning to the collector but hold little or no value to the people inheriting the collection. It’s essential to get an idea of the heirs’ intentions. If a client’s heirs intend to sell a collection, you may wish to counsel the client on other methods of disposition that don’t include the outright bequest of the collection to her heirs. Even if a client’s heirs desire to inherit the collection for their personal use, a client should know whether her heirs wish to keep only select pieces or the collection in its entirety.

If collectibles aren’t wanted by the family, or if their inclusion in a client’s estate will cause a substantial estate tax, charitable giving options may provide an answer. Although not always the primary motivation for charitable gifting, a client should be properly counseled on the income tax benefits of making a lifetime gift of some or all of her collection to a charitable beneficiary. However, before designating a charity under a client’s planning documents as the beneficiary of her tangible personal property or making a present gift, communicate with the donee charity to ascertain whether it will accept the property, as well as any restrictions a client wishes to place on its use.

Any client who owns a substantial collection should familiarize herself with dealers, appraisers, museum curators and other collectors in the area of her collection’s concentration. Such experts can provide valuable information on sales, buyers and current market prices, as well as assist with future purchases to round out her collection. This is, of course, in addition to an attorney and a full team of experts who can handle the legal and financial aspects for her, including a financial advisor, a tax specialist and a succession planner.