Many people take pleasure in collectibles and have perhaps amassed sizable and valuable collections of art, stamps, coins, jewelry, antiques or other forms of tangible personal property. However, despite the pervasiveness and often high value of these items, their owners often fail to plan adequately for their disposition.
Fortunately, multiple options are available: Owners can (1) sell a collection to monetize it; (2) gift it to family or friends during their lifetime or as an inheritance at death; (3) donate it to a publicly supported organization such as a charity or museum; or, (4) in a less commonly known strategy, donate it to their own private foundation.
Why A Foundation?
Unlike a public museum that depends on fundraising for its operations, a private foundation is funded and controlled by an individual, family or corporation.
And gifting a collection to a foundation helps a donor avoid a number of concerns he or she may have about donating to a public museum: For instance, the museum may not be willing to accept the collection if the artist is unknown or the art doesn’t meet its curatorial standards. Even if the museum does take the material, it may sell off lesser pieces when the donor wants to keep the collection intact.
By donating to a private foundation instead, the owner ensures that the collection remains a permanent holding, either for investment purposes or for public display. Collectors can also reap a substantial tax deduction if they donate to a foundation during their lifetimes, depending on the circumstances. Plus, a private foundation creates nearly endless charitable giving opportunities—giving donors the ability to make grants, offer scholarships or run service programs, etc.
If an owner decides that establishing and donating to a private foundation is the way to go, there are two distinct categories to consider: starting either an operating or a non-operating foundation. The differences between these two will be elaborated on further, but it comes down to the ways donors want to dedicate themselves to charitable activities and the resources they want to use.
Operating foundations directly operate their own charitable activities (rather than making grants to nonprofits) and must be significantly involved in the operation of their projects, including things like museums, zoos, libraries and research facilities.
Non-operating foundations can also conduct their own direct charitable activities, though doing so is not their primary focus. They typically provide grants to public charities, but they can also make grants to foreign and domestic organizations that aren’t recognized as 501(c)(3) entities, as well as make various grants to individuals. Because of the giving flexibility they offer, they make up the vast majority of the private foundation community.
The Case For An Operating Foundation
The appeal of operating foundations is that donors get the same tax benefit they would gifting to a museum or some other public charity while retaining complete control over their collections. Moreover, a donor can determine how the foundation uses the collection to fulfill its tax-exempt purpose (though the collection cannot be displayed on the property of a foundation insider).
The foundation can lend the art to a museum or university (as opposed to gifting it outright), which ensures the items won’t be sold or warehoused. And when the work is exhibited at a prestigious museum or institution, it benefits from the institution’s reputation and cachet, which may boost the collection’s perceived quality and monetary value should the foundation one day decide to sell it. If the donor wants to exert even more control over the art (or if prestigious institutions aren’t clamoring to borrow it), the foundation itself can choose to display it—either in private galleries by appointment or in privately funded museums open to the general public.
There are some conditions: First, the operating foundation is required to spend 85% of its net investment income directly on direct charitable expenditures each year. What’s more, if the foundation’s charitable purpose is to share its collection with the public, and the donor puts it in a private gallery or museum, the public must have ready access. The foundation’s tax status can be imperiled by restrictive limitations, such as its “by appointment” viewing, if access is too limited.
There also can be considerable costs associated with this type of foundation: It must bear every expense, whether it’s related to maintaining a clean, safe, insured and climate-controlled building, or hiring staff to care for the art, manage public relations and admit museumgoers.
But perhaps the biggest drawback of an operating foundation is that it doesn’t give the donor flexibility to do much else other than conduct its direct charitable programs. To maintain its status, the foundation must periodically show that it’s using most of its assets for its pledged charitable purpose. Though it can make grants to organizations, these will not count toward the IRS requirements necessary for it to maintain its operating status.
The Case For A Non-Operating Foundation
If collectors don’t want the pressure or ongoing obligation of running an operating foundation, they might want to contribute their collection to a private non-operating foundation. The annual charitable contribution deduction is limited to 20% of the donor’s adjusted gross income when it comes to donating property, and the deduction will be limited to the cost basis of the art (or the fair market value if it is less than the price a collector originally paid). That means donating the art to a private, non-operating foundation may be less tax-efficient than donating to a public charity or operating foundation.
However, this option may be the best choice if a donor wants to maintain control over a collection while engaging in other philanthropic interests. Consider these advantages:
It offers control: Like its operating counterpart, a non-operating foundation gives the donor complete control over the disposition of his or her collection.
It offers philanthropic flexibility: While non-operating foundations must satisfy an annual 5% payout requirement, they aren’t required to spend any portion of their assets on active charitable programs (though they are permitted). This means that in addition to sharing a collection with the public, the foundation could support nonprofits relevant to its mission or fund unrelated charitable objectives. For instance, the foundation could make grants to nonprofits that provide relief to hurricane victims, fund STEM education programs, or build housing for the homeless. The possibilities are nearly limitless.
The donor can display the collection: Non-operating foundations can lend their collections to museums and other institutions or choose to display them in a dedicated space. That’s because, in addition to making grants (the primary way they further their missions), these organizations are also permitted to use their assets to run programs.
If art is held strictly as an investment, there are some considerations to keep in mind. All non-operating foundations are required to distribute a minimum of 5% of their previous year’s net average investment assets annually (it’s colloquially known as the “minimum distribution requirement,” or MDR). Therefore, if a non-operating foundation is funded primarily with collectibles held as investments, the foundation will need sufficient liquidity to meet its annual payout requirement and maintain operations.
And because the market for collectibles and individual pieces can fluctuate considerably, the foundation will need to conduct regular annual appraisals to determine its 5% payout requirement for the next year.
It’s possible for a foundation to dispose of works over time by gifting them to a museum or another institution. Alternatively, a foundation can liquidate the collection, in part or in whole, and use the funds to meet its annual payout requirement.
Collectibles held as investments by the foundation require additional planning to ensure sufficient liquidity, so it might be preferable to hold art as charitable use assets. If the collection is publicly displayed or actively used by the foundation to carry out its mission (for example, if the foundation lends the work to a public museum), the value of the assets may be excluded from the calculation of the foundation’s required distribution.
Numerous Benefits
Private foundations offer numerous benefits to donors. And thanks to advances in technology, the cost and complexity in starting and administering a private foundation have dropped precipitously. Given that many high-net-worth individuals embrace a commitment to philanthropy, and that donating tangible personal property—from artwork to baseball cards—is an opportunity often overlooked, private foundations are an option well worth considering in estate planning discussions.
Jeffrey Haskell, J.D., LL.M., is chief legal officer for Foundation Source, which provides comprehensive support services for private foundations. Contact him at [email protected].