Now my advice for those who die
Declare the pennies on your eyes
'Cause I'm the taxman, yeah, I'm the taxman
-The Beatles
"The beatles had it right. They knew [that] no matter what we do, we have to deal with the tax man," says Ralph Lerner, a well-known art law attorney with Withers Bergman LLP in New York City.
The "tax man," or, more formally, the Internal Revenue Service, is keen to be dealt with when a death occurs. It is especially keen on getting its cut of long-term capital gains. Art that has appreciated in value falls into this category, which means it can be taxed at 28%.
Even without the taxes involved, there are reasons to donate instead. Sometimes, when a donor dies, his or her children don't want the art, Lerner says. Or they end up fighting over it. Or the grandkids poke a hole in a painting. It happens-a lot.
"It's a very scary thing," Lerner says. Take the case of Steve Wynn, who punched an elbow through a $139 million Picasso painting. No kidding, but an example how accidents can happen.
So to avoid accidents and a big check to the IRS, Lerner believes the cleanest and simplest thing for the donor to do is leave the work to a public charity. "The lifetime transfer of a work of art to a charitable organization saves the individual donor income taxes because of the allowable income tax deduction," Lerner explains. "At the same time, the lifetime transfer relieves the donor of the expense and the worry connected with the maintenance of a valuable work of art."
For example, he says, a painting that cost the donor $1,000 originally may have a fair market value of $10,000 today.
"A contribution today of the painting to charity that meets all the requirements ... produces an allowable charitable deduction of $10,000. For someone in the 35% tax bracket, such a contribution saves $3,500 in federal income taxes. Since the donor's out-of-pocket cost was only $1,000, the taxpayer has made a $2,500 tax-free economic profit and has enjoyed the use of the painting through its years of ownership at no cost. The problem is to make sure the contribution is correctly made."
Put an extra zero or two at the end of these numbers and the tax savings become even more compelling. Moreover, the property is taken out of the estate, which saves any taxes that may have been incurred.
But making the charitable contribution correctly is no easy feat. There are myriad hiccups, loopholes and mad rules to follow when it comes to gifting art. For example, to make a donation of a work, the donor must determine the status of the charitable organization (foreign tax-exempt organizations aren't allowed) and the type of property being contributed (art is weird in this way-it is valued by both property and copyright, two separate assets). The donor must also decide whether the art satisfies the "related use rule" (if a museum, for example, accepts the art to put on display but instead sells the work, it runs afoul of anticipated "use" and 100% of the deduction will be lost). And the donor must determine whether there is a qualified appraisal prepared by a qualified appraiser.