Another of life’s certainties: Art and Taxes, with legal art expert Diana Wierbicki

Sotheby’s New York
November 2016 Evening Sale

DESPITE THE TREPIDATION THAT FACED THE NEW YORK AUCTION HOUSES IN ANTICIPATION OF LAST WEEK’S NEW YORK NOVEMBER AUCTIONS, THE RESULTS WERE REASSURINGLY STABLE. QUALITY WON AND ALTHOUGH A MORE JUDICIOUS AND CAUTIOUS ATTITUDE PERVADED THE SALES ROOMS, AT THE SAME TIME, RECORD PRICES WERE ESTABLISHED IN IMPRESSIONIST, MODERN AND CONTEMPORARY SECTORS.

Claude Monet (1840-1926)
Meule
signed and dated ‘Claude Monet 91’ (lower left)
oil on canvas
28 5/8 x 36 ¼ in. (72.7 x 92.1 cm.)
Painted in 1891

A NEW WORLD AUCTION RECORD FOR CLAUDE MONET’S GREAT WORK FROM THE GRAINSTACK SERIES WAS ESTABLISHED AT $81 MiLLION AND KANDINSKY’S 1935 OIL REALIZED SLIGHTED OVER $23 MILLION. AT SOTHEBY’S CONTEMPORARY EVENING SALE, GERHARD RICHTER’S A B, STILL TRIUMPHED AT $34 MILLION AND A NEW RECORD PRICE OF $11.7 MILLION WAS ESTABLISHED FOR ARTIST DAVID HOCKNEY’S MONUMENTAL WOLDGATE WOODS, 24, 25, and 26, OCTOBER 2006. 

AS THE ART MARKET CONTINUES TO HOLD SWAY AND RECORD PRICES ARE REALIZED AT AUCTION, THE PRACTICE AND FOCUSED SERVICES OF LAWYERS EXPERIENCED IN ART LAW, THE ART AND AUCTION MARKET AND MUSEUMS AND ART FOUNDATIONS HAVE GROWN IN GEOMETRIC PROGRESSION.

AS ALL PARTICIPANTS IN THE ART MARKET FACE ART SPECIFIC ISSUES OF OWNERSHIP, THIS TIMELY ARTICLE BY FORBES’ GUEST EXPERTS DIANA WIERBICKI AND SETH COHEN OF WITHERS BERGMAN FOCUSES ON THE TAX CONSIDERATIONS AND CONSEQUENCES OF THE ACQUISITION AND DEACCESSION AND ESTATE PLANNING OF ART IN THE UNITED STATES.

Wassily Kandinsky (1866-1944), Rigide et Courbé, 1935.
Oil and sand on canvas. 44⅞ x 63⅞ in
Estimate: $18,000,000-25,000,000.

PART II

Timeframe for Resale

A factor generally reviewed by NYS when determining whether a purchaser is a reseller (vs. a collector or investor) is the amount of time it takes for the purchaser to resell the art. This is a challenging factor for sellers of art because art that is fresh to the market generally garners higher prices. For art to appreciate enough to result in a profitable resale, it cannot be sold immediately after purchase. Therefore, the turnover of items for resale in the art market is not analogous to the timing of resale in other markets. This is at odds with the traditional notion that the longer an item is owned, the more it looks like investment property instead of inventory for resale, and suggests that NYS should be analyzing the resale timing in the context of the art market structure. That being said, there is no guarantee that NYS will take art market nuances into account when applying their general rules. In case of an audit or investigation, it is advisable to highlight art industry differences as a way to counterbalance the importance of this factor. Since the determination as to being a reseller looks at all relevant facts and circumstances, it is prudent that a putative reseller with long periods between sales ensure that the other factors be legitimately in the reseller’s favor.

Gerhard Richter
B. 1932
A B, STILL, 1986
oil on canvas
88 1/2 by 78 3/4 in. 224.8 by 200 cm.

A few of those factors are: (i) whether the purchaser maintains a gallery or specific place of business; (ii) whether the purchaser is an expert in the applicable area of art; (iii) whether the purchaser has employees; and (iv) how the purchaser reports and treats the income derived from sales (i.e., a purchaser cannot have it both ways – by claiming reseller status, while treating the income from sales as investment income subject to capital gains rates). In other words, a reseller operates a business and the more that business acts like a business, the greater the chance that it will survive unscathed by any NYS scrutiny. If investigated by NYS, having complete documentation as to these factors is key as many an investigator or auditor has been swayed by both the information contained in the documentation and the propositions for which they stand.

David Hockney
WOLDGATE WOODS, 24, 25, AND 26 OCTOBER 2006
oil on canvas, in six parts
overall: 72 by 144 in. 182.9 by 365.7 cm.

Selling Art off the Walls of a Home

There may be a valid business reason for displaying art in a personal residence, but by doing so, you invite a struggle with NYS. For example, a reseller’s home may be a great place to display art during orchestrated gatherings with potential buyers to show clients what the art looks like in a home environment. Nonetheless, despite valid reasons for home displays, NYS will highly scrutinize them and, to be frank, NYS is not without justification. NYS has the understandable view that a home display carries with it the purpose of personal use, namely the enjoyment of the art. This is not to say that home display is an automatic disqualifier, but a reseller argument where there is home display will likely be an uphill battle with investigators given their assumption that the reseller exemption is inapplicable. We note that, in some cases, having an area within the home used solely for business purposes has proved successful in defending against taxes and penalties in an audit and subsequent litigation.

 

Guest post by Diana Wierbicki and Seth Cohen, FORBES , May 10, 2016, in Janet Novak: Taxing Matters 
Diana Wierbicki is global head of art law and Seth Cohen is a partner specializing in tax controversies at Withers Bergman.

AND NOW, A WEEKEND OF FAMILY, FRIENDS, FOOTBALL, AND FOR SOME INCORRIGIBLE FEW, FITNESS! HAPPY THANKSGIVING FROM THE LRFA BLOG!

Wayne Thiebaud
Turkey Dinner
For the cover of the New Yorker
November 21, 2011

A case of fractional art interests with art law expert, Diana Wierbicki, of Withers Bergman

JOHN DIZARD, A JOURNALIST AND CONTRIBUTOR TO THE FINANCIAL TIMES, RECENTLY STATED, IN FT’S FEBRUARY 5, 2016 EDITION, THAT THE BUSINESS OF LENDING AGAINST ART HAS NEVER BEEN BETTER. HE DOCUMENTS THE SURGE OF NEW CAPITAL THAT IS TRYING TO GET INTO THE FINANCING OF ART-RELATED PURCHASES AND LOANS. BIG BANKS OFFERS RELATIVELY LOW RATES ON THEIR ART LOANS AND SPECIALIZED LENDERS ARE OFFERING LOANS TO EUROPEAN CLIENTS WHO DO NOT MEET THE CURRENT LENDING STANDARDS OF THE CONTINENT’S BANKS. IN THIS WAY, CASH-SHORT COLLECTORS CAN RAISE MONEY BY BORROWING AGAINST THEIR ART INSTEAD OF SELLING IT AS WE APPROACH A TIME WHEN AUCTION RESULTS ARE BECOMING SIGNIFICANTLY LOWER WITH THE EXCEPTION OF FIRST-TIER OR MUSEUM QUALITY WORKS.

http://www.ft.com/intl/cms/s/0/0d4a50f0-cbff-11e5-a8ef-ea66e967dd44.html#axzz3zWBNew5p

ESTATE PLANNING FOR HIGH NET WORTH INDIVIDUALS, FAMILIES AND FOUNDATIONS WITH STRONG ART HOLDINGS HAS BECOME INCREASINGLY COMPLEX AND SOPHISTICATED AND THE NUANCES AND INTERPRETATIONS OF ART LAW REQUIRE SPECIALIZATION AND EXPERTISE. THE LRFA BLOG IS DELIGHTED TO SHARE AN ARTICLE BY LEGAL EXPERT, DIANA WIERBICKI, ON FRACTIONAL ART INTERESTS THAT WAS PUBLISHED IN WEALTHMANAGEMENT.COM IN SEPTEMBER 2014.

Diana Wierbicki is a New York-based partner at the international law firm Withers Bergman,  where she focuses on art law dealing with purchases, sales, loans, consignments and charitable giving of works of art. Ms. Wierbicki is also a member of the wealth planning practice group and advises high net worth individuals and their families on tax, trust and estate planning matters, as well as on commercial transactions associated with that planning.

 

APPEALS COURT GRANTS SUBSTANTIAL DISCOUNT FOR ART INTERESTS

In Estate of Elkins v. Commissioner, the descendent’s estate gets a $5 million estate tax refund

The U. S. Court of Appeals for the Fifth Circuit reversed the Tax Court’s decision in Estate of Elkins v. Commissioner and increased the discount for the decedent’s fractional art interests, resulting in a $14 million estate tax refund for the decedent’s estate.

The Tax Court had previously rendered an opinion in 2013 granting the Estate of James A. Elkins, Jr. a 10 percent discount from the pro rata fair market value of the decedent’s interests in 64 works of art.  On appeal, the Fifth Circuit disagreed with this nominal percentage and accepted the discounts originally offered at trial by the estate’s expert witnesses, which ranged from 52 percent to 80 percent.  These discounts even exceeded the 44.75 percent discount originally reported on the estate’s return.

Facts

James Elkins and his wife had lived in a community property state.  James survived his wife and died owning a 73 percent interest in 61 works of art and a 50 percent interest in three works of art.  At that time, his children owned the remaining interests in the art.   During James’ life, the art was primarily held in his house or office, and a lease agreement and co-tenants’ agreement with regard to the art existed between him and his children.

When James died in 2006, his children inherited his undivided fractional ownership interests in the art, and his residuary estate passed to a family foundation.  James’ estate tax return applied a 44.75 percent fractional interest discount in valuing James’ art interests, which the Internal Revenue Service denied in its entirety.

Tax Court Ruling

The Tax Court rejected the IRS’ argument that no discount should apply and, instead, valued the decedent’s fractional interests using a hypothetical “willing buyer/willing seller” analysis.  The Tax Court noted that although both parties brought expert witnesses, only the estate introduced evidence as to the appropriate discount amount.  The IRS—committed to its position that the decedent’s interests shouldn’t receive any discount—offered expert testimony that there was no recognized market for the sale of such interests and failed to argue in the alternative for a specific discount value.

The Tax Court was most influenced by the testimony of one of the decedent’s children.  Relying on the daughter’s statement that she would be willing to pay a “fair price” (meaning one determined by an expert) to keep the art in the family, the Tax Court presumed that all of the decedent’s children would ask for little to no discount.

The Tax Court determined that the fractional interests should only receive a minimal valuation discount of 10 percent for estate tax purposes.  As such, the Tax Court rejected the estate’s suggestion that a hypothetical owner of the decedent’s fractional interests, cognizant of the children’s determination to outlast any third party who attempted to force a sale of the interests, would need to sell the art to the children at a sharply discounted value. Without expert testimony from the IRS analyzing the appropriate discount, the court seemingly picked a percentage discount amount out of thin air.

Higher Discounts Warranted

On appeal, the Fifth Circuit affirmed the Tax Court’s holding that fractional-ownership discounts apply to interests in art.  However, the Fifth Circuit found that the Tax Court’s application of a 10 percent nominal discount was a reversible error, given the absence of any evidence or legal arguments supporting such an amount.

The Fifth Circuit found that the Tax Court’s focus on the children as owners of the fractional interests undermined the objectivity of its “willing buyer/willing seller” analysis.  The Fifth Circuit criticized the Tax Court for not giving sufficient weight to factors that would realistically inform a hypothetical buyer’s or seller’s price.

In addition to considering the children’s resolve in maintaining absolute ownership and possession of the art, the Fifth Circuit revisited the testimony of the estate’s expert witnesses.  The Fifth Circuit agreed with the experts that a potential willing buyer of the decedent’s fractional interests would be aware of the family’s financial strength and sophistication, as well as existing restrictions on selling the interests.  Such factors would outweigh the appeal of a guaranteed “fair price,” and lead a buyer to purchase the interests only at a large discount.  Moreover, the Fifth Circuit observed that the so-called “fair price” that the decedent’s daughter was willing to pay would likely be informed by the same experts as in the present case, whose valuations supported much higher discounts.

Widened Range of Discounts

This was a tremendous win for the estate and has drastically widened the range of discounts for fractional interests in art.  This is a dramatic increase from the 5 percent discount for fractional art interests that was granted in Stone v. United States in 2007.  The Fifth Circuit emphasized that the estate’s evidence on discount valuation was the only evidence on that issue because the IRS was unable to introduce any evidence as to an alternate discount valuation, having failed to do so at trial.  It’s therefore unclear where future discounts for art interests will land within the court-established range if the IRS abandons its no discount argument in the future.

– The author acknowledges Sarah Pickering for her assistance with this article.