From the November 2008 issue of Investment Advisor • Subscribe!

The Fine Art of Planning with Collectibles

The nature of collectibles calls for a specialized approach to planning

Many affluent clients have a serious passion for collecting--and for some it reaches the level of obsession--with a range of interests from exquisite art to pop-culture memorabilia. When a blue-and-white gingham dress worn by Judy Garland in the Wizard of Oz can sell for about $240,000, or a case of '61 La Chapelle Rh?ne wine goes for $247,747, a lifetime of accumulation can lead to a collection that represents a significant portion of a client's net worth. That collecting passion can be imbedded in the client's lifestyle, too, and may be a key element in understanding how the client thinks.

Clients with collections need specialized planning help, since the tax laws for tangible personal property are so different from tax laws for securities. Someone who purchased $100,000 worth of Microsoft ten years ago and sold it for $1 million would owe 15% on the federal capital gains. A Picasso print purchased for that same $100,000 on the same day and sold for $1 million today would result in 28% capital gains tax.

When it comes to settling an estate without a plan for the collectibles, the net value of a collection can be considerably less impressive than the artistry represented by the pieces. Disposing of valuable collectibles without an estate plan can lead to a loss of 60% to 80% of the actual value, according to art planning advisor Michael Mendelsohn of The Briddge Group in Rye Brook, New York. The nine months the IRS provides to pay estate taxes may occur at a down time in the collectible market, resulting in a sale below typical value. Auction fees, capital gains taxes, and estate taxes then dramatically reduce the net value of the selling price. Also, pieces sold individually over time would likely result in a higher total selling price than the same items sold as a group at one time. Then, of course, the client's estate could face an even less favorable problem--about 20% of items up for auction don't sell. The estate taxes due on the unsold property would need to come from other assets or a private sale at probably a large discount.

A Very Special Asset Class

Collectibles are a very special asset class--one that takes experts to analyze, value, and incorporate as part of an advanced planning strategy. As a committed art collector along with his wife (they've been included in a list of America's top 100 collectors), Mendelsohn understands the passion and financial planning needs of his clients. Since every client and collection is different, he assembles an appropriate team composed, for example, an expert in the type of collectible, an appraiser, and an expert in museums or the world of dealers. They work in coordination with the client's financial advisors and attorneys. "The team knows how to weave its way through the museum world, through the auction world, and through the dealer world. Then, we hook up all of that expertise in designing individualized plans for almost every piece within the collection for whatever the client wants to do. We have no pre-conceived ideas. We're not dealers of art. We don't sell products," he notes. They explore options to give collectors the opportunity to make informed decisions about what they would like to do with 30 or 40 years of their life represented by the collections.

The tax consequences of selling collectibles are just one issue, especially when it comes to art and other rare valuable objects. The first task of a collectible advisory teams is to assess what the client actually owns, how they acquired it, and what they paid for it.

At first, an inventory of items may appear an obvious and simple initial step, but the implications are not. Movie director and producer Steven Spielberg has been a fan and collector of Norman Rockwell paintings for many years, even helping to fund the building of a museum devoted to the artist in Stockbridge, Massachusetts. Rockwells hang on the walls of his studio offices. Last year, however, Spielberg learned that one of his Rockwell paintings--Russian Schoolroom--had been stolen from an art gallery many years before he purchased it for $200,000 from a reputable dealer. And even today, collectors and museums are confronting the issue of returning art and cultural property captured during World War II in Europe. One painting may not represent a significant portion of Spielberg's estate, but for another collector, having to give up such a piece to its rightful owner could represent an unexpected personal and financial loss and less flexibility in creating a philanthropic legacy.

As it turns out, the art may be rare but theft isn't. The U.S. represents the world's biggest market for stolen art, according to the FBI. The Wall Street Journal reports that 16,117 artworks in the U.S. were listed by the London-based Art Loss Register last year as missing or stolen, having risen from 14,981 the year before.

Before discussing planning strategy or philanthropy, the team resolves any issues of ownership or authenticity. For example, does the client really own an original 1814 copy of the first book to tell the story of the Lewis & Clark expedition (worth about $35,000)--or a very well crafted, but mass-produced reproduction? Alternatively, if the client has been become more passive in his or her collecting and hasn't recently tracked the market value of the collection, some surprises could arise. What was thought to be a $20 million estate may turn out to be worth several million more when the market value of the collectibles is included--a surprise that can bring more flexibility but more tax obligations, too.

A Philanthropic Legacy

The team also needs to look at what kind of legacy the family wishes to create (or continue), since it can take many forms beyond outright gifts to museums or nonprofits. The balance between inheritance for the designated heirs and gifts for philanthropic causes becomes a multi-dimensional decision that's not only highly individual to the family but also even to each collectible item.

Rather than giving art outright to a museum, for example, the client can gift those pieces to a family foundation, which then lends the pieces to various museums worldwide or just a favorite one nearby. Such a foundation offers several benefits for the client's children and later generations. Fifty years after the death of the client, great grandchildren could run the foundation and have a personal connection and insight to great-grandparents they never knew via the very personal statement a collection represents.

Lending collectibles to museums or nonprofits rather than gifting them also prevents the organization from selling a collectible item to buy something else or to just balance an annual budget. If the client does want to give pieces outright, the collectible planning team would evaluate potential homes for appropriateness and level of commitment.

While clients may have charitable intentions or even serve on the boards of nonprofit organizations, leaving a rare stamp collection to a favorite wildlife preserve would only result in an auction to create more useful cash.

Mendelsohn uses a solution more helpful to clients and to the charity. "If, for example, a client wants to give the Ronald McDonald House a $5 million painting, and it didn't have an art program or didn't show art on their walls, the tax deduction would be limited to what the client paid for it, not the current value. So, we may talk to clients about the possibility of borrowing against the painting. There are sources available that will do that. You get a loan against the painting and you give Ronald McDonald half the cash, for example. Now, you get a tax deduction, the painting stays on the client's walls and depending on how long he wants to keep it, he could roll the interest into the loan or he could pay the interest--if the lawyer has set it up correctly--as a deductible item."

Eventually, if the client wanted to sell the painting, he could do that and pay off the loan. Alternately, he could just repay the loan himself and put the painting into a CRT (charitable remainder trust). The CRT can then sell the painting, give the collector a stream of income and give the Ronald McDonald House the principle at his death. The flexible CRT solution works with any collectible and the principle can also be divided among more than one charity.

Leaving it to the Kids

A favorite family vacation home or rare automobile or even a painting can be shared among siblings on a time rotation basis. Collectibles, however, can present some more complexity in families where more than one child shares the parents' passion for certain objects. A client of H. Chandler Taylor, of the Moneta Group in Clayton, Michigan, has a 1932 Art Deco Steinway piano that both the son and the daughter of the owner would like to inherit. It's the instrument on which they took lessons as young children, so they are quite attached to it. For the last seven or eight years, the family has been trying to identify an emotionally satisfying solution, such as a new Steinway for the "loser," but they haven't yet quite come to resolution.

If the children do want the family collectibles, and the client has charitable intentions--the planning team needs to balance several factors--the estate tax exposure, the grantor's wishes and income needs, appropriate distribution among the children (which may not be completely equivalent in pure dollar-values), and the selection of the right type of charity or non-profit organization. In addition to the CRT, family limited partnerships are a common tool advanced planning teams use in these situations.

Mixing Philanthropy and Collectibles

For collections where the objects are relatively mobile--especially those with historical or popular appeal--the client, a trust, or a foundation can lend the items for fundraising.

"I've always said that the Baseball Hall of Fame is in the wrong place," says Mendelsohn, by way of example. "It's in Cooperstown. I love baseball, but I have yet to go up there. Part of that collection could be touring to raise funds for the local PAL, for the local Little League, or kids with cancer, etc. So, you can turn interesting objects and a collection into something that can do good for the general population as opposed to being housed in a building where a limited amount of people will go see it."

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