When your client inherits artwork, what should you know about helping them handle this new and unique type of investment? 

Antiques Road Show has long lines of people bringing their art, jewelry, furnishings and other collectibles to be appraised. The excitement of watching people realize that they have inherited an item worth tens, if not hundreds, of thousands of dollars (as well as watching the agony of someone being told a treasured heirloom is worthless) is what makes the show so interesting. Your clients have the same emotions when they inherit artwork or other collectibles. They are thrilled, but they are also agonized. They hope that the inheritance is worth a fortune, but they fear that it is worthless and are indecisive over what to do next. As their trusted financial advisor, they will turn to you for your support.

Financial advisors often refer clients to us who are in these situations. One such client inherited his uncle's collection of Americana, which included many fine pieces of furniture. When a proper inventory was done, the most valuable piece was found to be not the furniture that was appraised highly in the estate, but a greenish pot that had always sat on top of the family refrigerator. The outcome: The client sold the pot for more than twice what the rest of the collection was valued at, and we were able to defer income taxes through a like-kind exchange.  

Another client inherited his father's coin collection. Only eleven coins from this vast collection were worth more than their face or metallic value, yet those eleven were worth many times the value of the rest of the collection. 

When your clients inherit artwork, coins, or other "treasure," they suddenly have a significant portion of their net worth tied up in tangible personal property. A recent Barclay's Wealth Insight Report showed that these treasure assets are becoming a major percentage of the "mid-tier" client's wealth -- up to 10 percent in the U.S., and 20 percent globally. As their advisor, your assistance to the client should be focused on how to balance your client's existing investment, legal, financial and insurance planning with the new, specialized planning needed to manage these unique assets. Your role may seem limited to the execution of your client's specific direction as to what to do with the money when items are sold, from where to take the money when assets are purchased, or to keep track when artwork is donated. You may also see your job as tracking the items on the client's balance sheet and financing the costs of acquiring and maintaining the collection. Your clients will, however, look to you for support in handling a newly inherited collection.

(Two other kinds of financial advisors serve owners of collections: an enabling advisor and a collections advisor. An enabling advisor provides clients with active help in sourcing how to finance the collection and provide access to types of tax strategies and collectible investment techniques, either through funds or through your client's direct ownership of treasures as investments.  A Collection Adviser provides the bespoken investment services of a niche collectibles firm, and all of the regulatory and specialized knowledge that implies, and they provide clients direct advice on specific items, manage the outside expertise and experience, and bring their knowledge to bear on the client's collectible portfolio.  Often these include access to independent curatorial staff, and work to actively manage and structure the collection.)

The greatest risk, and concern, of your clients is that they do not know the true value of the artwork or other collectibles they have inherited -- not can they readily find that value like they can for stocks, bonds or even real estate. Even before getting the required expert opinions on the value of each item, there are three steps that you will need to help your client with as they adjust to the ownership of artwork. These are 1) inventorying the collection, 2) simplifying the collection through a process of aggregation and 3) laying the groundwork for the management of your client's collection. All of these are necessary to avoid selling a rare piece at a fraction of the cost, or spending a large amount for an item that has legal ownership or other defects.

Step One: Inventory
Most collectors do not have a current inventory of their assets; or if the inventory does exist, it is lacking critical information or in a format that is cryptic in the extreme. Inventories in the estate often are geared towards minimizing the estate tax value of the asset, and are rarely complete or sufficiently detailed.  They are also sometimes confusing because artists often work in many different media, so it is often difficult to determine who created what artworks in the collection.  Therefore, your client will need expert assistance to describe assets for the inventory.  At the minimum, inventories should include:
    List of works created by an artist and in your client's possession;
    Authors (including joint authors and collaborations and contact information);
    Dates of both creation and acquisition;
    Contracts associated with any works, such as licenses, assignments, etc.;
    Where the items are located;
    Galleries or dealer names and along with their contact information; and any paperwork that refers to the artwork, such as catalogs, bills of sale and so forth.

Whether you use a spreadsheet, other software program, or even old-fashioned card catalog systems, beginning the inventory is critical.

Include in the inventory any reference to contractual relationships that might exist, including consignment agreements, copyrights, distributions, and reproduction rights. Remember that ownership of artwork does not convey the copyright to that artwork, and in some countries artists retain some rights over the transfer and display of art even after sale.

Step Two: Aggregate
Even when all of the significant artwork is clearly inventoried, researched, labeled, and stored, your client will most likely be confronted with a large number of items, not only easily recognizable valuable art, coins, gemstones, jewelry, furniture, or other collectables, but also the associated masses of documents, catalogs, notes, letters, bills of sale, and paperwork. Although it does not seem like much, a single piece of paperwork can be critical for determining the provenance (and therefore value) of an item. In order to support your client and their new collections of items, each with many different taxes, provenance, and valuation issues, you must help them simplify.

A critical first step to simplification is aggregating1 items and their associated paperwork. Items with similar characteristics are formed into groups and these groups are given certain rules or guidelines based on trends in the taxes, recognition, and liquidity premium as well as your client's desires.

Taxes: Your client's income from transacting tangible assets is taxed differently than their investments or ordinary income.  How your client handles the ownership of the collection will control the subsequent income tax treatment of their buying or selling tangible assets.  The IRS recognizes four distinct types of taxpayer based on the role that the taxpayer plays prior to a transaction:  Collector, Investor, Business Investor, and Dealer.  Although the IRS will assume your client is a Collector (thus imposing the highest capital gains tax and allowing the fewest deductions), in reality your client may qualify for the more advantageous tax status of Investor, where more deductions are allowed as well as the use of techniques such as like kind exchanges.  Qualifying as an Investor is not as simple as a declaration, and requires a well-documented pattern of behavior by your client; but a qualified expert can help your client position himself to obtain the most desirable tax status.

Recognition: The value of some of your client's collection will be much more susceptible to market forces than others. This may be because of the general standards of taste, critical acclaim, the vagaries of provenance and authenticity, the role the item plays in the culture, and changes in laws banning the sale or purchase of certain items. The collection needs to be aggregated in terms of what has the more stable pricing  and what has more volatile pricing, questionable legality, or uncertainty of your client's  legal title to the item. Legal title (also called provenance) of artwork and collectibles is critical for your clients to be able to either keep the artwork, or get a fair market value for the artwork when it is sold. The problem is that the artwork market is much more unregulated and opaque than even the real estate market.2

Title: A good title to artwork is critical, especially today when claims can be made from miles away and from deep in the past. Once there is a "cloud on the title" of artwork, there is essentially no time limit by which an alleged prior owner must submit a claim.  Legal title to artwork is too often presumed to be clear in the mind of the current owner and advisor, and then when the piece is listed for sale or gifted to charity, the prospective buyer, the recipient institution, a trustee or fiduciary or a qualified intermediary (in the case of a reverse like-kind exchange, where this intermediate party must take and then transfer "clear" legal title of the asset in order to effect this tax strategy) have no guaranty of good title.3 As part of the inventory process, your client should review those items for which the legal title cannot be adequately certified, and they should obtain title insurance, much as your client would obtain when buying or selling real estate.

Liquidity: The ease with which your client can sell an item also factors into aggregation.  Rare, or unique, items by themselves may not be enough to provide liquidity; they must also be sought after by those willing to pay for the ownership and control of the item.  A highly sought after item can easily be sold at auction or private sale even if poorly executed or heavily damaged, while a well-executed and flawless item may languish for months or years.  Your clients may inherit a few highly liquid items and many illiquid items in the collection. By aggregating together the highly liquid items that your client wants to sell with the more illiquid items that also may need to be sold, you can give your clients leverage on negotiating fees, commissions and other costs on the sale. 

Premium:
Occasionally your client will inherit an item that they could only hope to own if they are willing to compete at auction with the most well-heeled collectors and institutions. These items can be key to the preservation of the rest of the collection, especially if planning has been done beforehand to allow for some of the estate tax avoidance in the settlement of the estate. These premium items are truly in a realm of their own, and require the most expert help in managing the preservation, transfer, or sale.4  

Step Three: The Management Of The Collection
As an adviser you may not play an active role in the buying and selling of art and other collectibles, but you need to support your clients in managing their collections.  As part of that management, you can best serve your clients by helping them find the professionals with the proper expertise and experience to manage the collection. To begin, consider working with your clients on the management and planning for the collection by asking the following questions:

Does your client understand the buy-sell discipline for their collection?  As with speculative investments, your client may own artwork that rapidly and permanently declines in value after they purchase or inherit it. Conversely, artwork that was out of fashion when it was inherited may just as rapidly increase in value, but only temporarily. Your clients need the same sort of discipline in managing the collection that you now provide them with on their investments; namely when to hold assets until the value recovers, when to sell assets to cut their losses, and when to sell some or all of a collection before the market declines. A collection needs to be reviewed with a critical but unbiased eye, and your client needs help understanding when a collection should be sold, and how it should be enhanced.

Does your client's personal representative readily know how to maintain and ultimately dispose of any artwork in your client's estate? In some circumstances a cultural executor such as a private curator or expert in the field may be better equipped than family members to manage the disposition of artwork. Additional funds should be allocated for such administrative costs. 

Does your client have insurance policies or funds from the estate that can help alleviate the burden of additional administrative and tax costs for the collection? Multiple types of insurance can assist with this. Life insurance should be held in a specified Irrevocable Life Insurance Trust intended to provide liquidity to a collection, and should be drafted specifically to allow investments in, and loans collateralized by, artwork and collectables. Clients and advisors are generally familiar with Property and Casualty insurance; clients and advisors should carefully consider title insurance on items of any significant value to manage transaction risk and to eliminate liability for clients when selling works.5

Do your clients keep their purchase and sale inventory records?
The names of galleries, dealers, and auction houses or other persons who might be interested in buying or selling your client's artwork should be in a place where your client's personal representative could readily find them in the event something happens to your client. Again, provenance has become critically important in the art world in the last decade, especially art coming out of Europe before and after WWII, and art coming out of countries in economic and political turmoil such as Russia in the 1990's.  Provenance will continue to grow in importance in the valuation of artwork. All ephemera associated with the artwork, such as auction catalogues, notes etc., should be retained and catalogued for future reference.

Has your client specifically addressed in his or her will the disposition of any copyrights your client may own? Unless the deceased is also an artist, it is unlikely that your client will inherit copyrights; but where there was collaboration between a collector and an artist, such rights may exist.  Be aware that copyrights can be created of an image of an object (such as a piece of furniture), which might otherwise be in the public domain.  Also, if your client is planning to make a specific item a donation to a charity during their lifetime or at their death, remember that that donation does not carry the copyrights to the object unless specifically mentioned; but a gift to an individual beneficiary of the same object will carry such rights.  Also, make sure that your client's personal representative can find records of the copyrights. By law, copyright transfers must be in writing and signed by the copyright owner.  In addition to a signed writing, the transfer may need to be recorded with the US Copyright Office. 

Does your client have specific instructions or restrictions on how items may be used or licensed? Some clients have a deep emotional attachment to the inherited collection and they feel a moral obligation that the items should not be sold, that new books in the same series should not be commissioned, music should not performed at certain venues, and so forth. Dealing with these restrictions will require significant cooperation with the future owners of the artwork or other items, so these restrictions should be clear and well drafted.

Has your client made arrangements for the maintenance and storage of the collection in the estate?  Estimate the total cost of the planned disposition of your client's art/collection, equipment, and supplies (including storage, distribution, conservation) upon your client's death, even if in the most basic terms.  Sending a grand piano across the globe may cost much more than the piano is worth, and the beneficiary may not be able to carry those costs without assistance. Also, if artwork or other items are placed in long term storage, one runs the risk of damage or loss if the storage faculty has a catastrophe. Your client's visual art in particular will need to be stored properly, as will photographs, film, and digital files.  
Has your client considered the use of split interest trusts and charitable foundations as helpful vehicles by which to manage art?  A trust, LLC, or Family Limited Partnership is the best way to manage a collection and its associated copyrights, licensing, and management costs when it is to be shared by a number of beneficiaries. In addition to a management trust, your client should be familiar with the use of split interest trusts (e.g., CRT, CLT, GRIT, GRAT) for transferring collections between generations.

Conclusion
Whether or not your clients star on Antiques Road Show, it is likely that they will inherit a windfall of artwork or other collectibles with the passing of the Baby Boomer generation. Your role is to help sustain your client as a new owner of the collection. To do this you need to help them get the expertise and experience to properly inventory their collections, simplify the collection management through aggregation, and prepare your clients on what they are going to do with their collections when their time comes to pass it on to another generation.

Matthew F. Erskine provides legal and fiduciary services for owners of privately held businesses and unique assets. Handling as many as seven generations of a single family in succession, his expertise includes planning for and managing collections for collectors, dealers and artists; integrating diverse, independent professionals for a unified planning process; funding and managing private family foundations; financial, operational, and corporate planning for family-owned businesses; and complex interstate and international financial, tax and estate planing, and trust administration. For this article, he also acknowledges the help of Lawrence Shindell and the staff at Aris Title Insurance for their input on the issues surrounding the legal title to artwork and other collectibles.

1For a more detailed discussion of the semiotic analysis of objects and collections, and related topics of aggregation, see Pearce, Susan M. (ed.) Interpreting Objects and Collections, Leicester Readers in Museum Studies, Routledge, 1994

2For a very readable work on how recognition can affect the value of contemporary art, see Thompson, Don The $12 Million Stuffed Shark: The Curious Economics of Contemporary Art Palgrave MacMillian © 2010

3For more information on the complex question of legal title in the art and collectibles markets, which is at the center of all tangible personal property asset management strategies, see the information at www.aristitle.com.

4On the effect of expert opinion on the value, and premium, of art, see Spencer, Ronald D. The Expert versus the Object: Judguing Fakes and False Attributions in the Visual Arts Oxford University Press © 2004

5It is not uncommon for clients to inherent, among other examples, a number of "Americana" paintings, each valued at, say, $50,000 but in combination worth, say, $500,000, which is a tidy sum to help with estate taxes or  other liquidity desires.  The question of when to incorporate risk management around the legal title issues in the tangible personal property asset class (of which "provenance" is just a subset) is a complex one.   Consider in the case of the 10 Americana works worth $500,000 that the U.S. government has an ownership right to works created under the New Deal Era Work Progress Administration ("WPA") program, which the federal government asserts when these works appear at auction and reclaims them.  It is also not uncommon for families to discover that they just inherited what turns out to be important historical documents, to which a state government lays claim when the family places the documents in the market for sale.  For a resource on the market title issues and the potential legal and financial impact of these issues, see note 2, page 5.