Most collectors are passionate about their collections and have spent many years—or even a lifetime—building it. But have they considered what will happen to the collection when they can no longer hold it? While transitioning a collection can be difficult, the old adage “you can’t take it with you” has significant meaning when it comes to one’s most valued treasures, whether they’re fine art, classic cars or even baseball cards.
There are essentially two main options for transferring a valued collection—either passing it along to family or donating it to charity—each with its own estate planning implications. When planning to transition a collection, value is about more than just dollar value; it’s also about the personal value to the owner and what it may mean to his family or to a charity. In this article, I’ll focus on transferring the collection to family. A follow up article will discuss transfers to charity.
Family’s Interest in Collection
The first thing to consider is whether family members are even interested in keeping the collection. While not everyone may share the collection owner’s penchant for Fabergé eggs, someone in the family may be glad to display those favorite treasures long after is the collector is gone. However, there are several factors that come into play.
While the family may be interested in inheriting the collection, they must be able to afford the upkeep, which can include expenses such as insurance, storage and special display needs, such as climate control. If they don’t have the funds to cover such expenses, then the owner needs to determine if there are sufficient resources to leave an endowment to maintain the collection. And, what happens if some family members, but not others, are interested: How do those who aren’t receiving the collection get compensated? And if the collection is split, how will that affect its value?
The first step is to obtain an appraisal for the collection as a single collection and as several smaller collections, or even as single items, in the event the collection might be split up. Next, it’s important to look into long-term storage, display and insurance costs, to find out how much of an endowment would be needed to cover these costs.
Gifts During Life or at Death?
It can be hard emotionally for a collector to give away some or all of a collection during life, but there are times when it may make sense. For example, the owner may have reached a stage in life when he no longer wishes to maintain a home large enough to house an art collection or no longer wants to pay for storage and insurance on a classic car collection. Or, the owner may simply want to share some of the collection with a family member who shares his or her passion. However, a lifetime gift has a number of tax and economic consequences. A gift of a collectible, like any other asset, will be potentially subject to the estate and gift tax. Smaller gifts can take advantage of the annual exclusion amount, currently $14,000. For example, a collector of art prints might be able to give away a substantial part of the collection through annual gifts of one print valued at $14,000 or less to every family member. Larger gifts, however, would use a portion of the federal gift and estate tax exemption, currently $5.43 million as indexed for inflation.
Giving during life can have an income tax cost. Choosing to give away a collectible that’s likely to appreciate during life can be very advantageous, as it not only pulls the current value of the gift out of the owner’s taxable estate, but it also takes the future appreciation out of the estate. However, there can be a future income tax cost for the recipients. Unlike an inheritance at death, when the heir receives a fair market value or “stepped up” basis, when an individual instead receives a lifetime gift, the basis of the asset is the same as it was in the donor’s hands, typically the initial purchase price. If the family member receiving such a gift then sells it, he would be subject to tax on all the appreciation since the collector’s purchase at the collectibles capital gains tax rate with a maximum rate of 28 percent. State income tax may also apply.
Gifting through a limited liability company and/or a trust. There may be times when it makes sense to place the gift in a vehicle such as a limited liability company or family limited partnership (collectively referred to as a “family LLC). When art is held in a family LLC, one can in effect fractionalize works of art by transferring family LLC units to family members. A family LLC may also allow for a discount on the value of the art for lack of marketability and transferability. Finally, a transfer of the art or of the family LLC holding it in trust often can provide a long-term vehicle for the safekeeping and maintenance of the artwork for the benefit of the family.
Avoiding Family Strife
It’s critical to communicate with family members as early as possible to determine who’s interested in what. If the collection can be split, how does the owner determine who gets the “best” car or the “rarest” van Gogh? Making these decisions before it’s time to inherit will help avoid family strife later. And determining how to treat fairly other family members who aren’t interested in the collection is equally important. Possible litigation among family members over valuation—or worse yet—“undue influence’” can significantly deplete the estate.
Once it’s been determined who wants the collection and any gift tax consequences of transferring it, it’s important to assess if there’s sufficient liquidity or other assets to make gifts or bequests to the family members not receiving the collection or to create an ”endowment” for family members receiving the collection, but who will need assistance maintaining it. However, it’s important for the owner to ensure that there’s liquidity to make such gifts without having to sell other assets during his or her lifetime.
Often, people wish to defer making lifetime gifts to avoid paying any gift tax. For bequests at death that are large enough to be subject to the estate tax, an irrevocable life insurance trust can be a good solution for estate tax liquidity needs, as well as “wealth replacement,” to make gifts of cash to family members who aren’t receiving portions of a collection. Insurance proceeds can also be used to provide an endowment to maintain the collection for those family members who inherit it.
Selling Collection and Gifting Proceeds
Sometimes, it may make the most sense to sell the collection as a whole, particularly if neither family members nor a charity is interested in it. The creator of the collection has likely spent years researching and maximizing its value and is likely more familiar with the market than his heirs. So the owner would be in the best position to make an informed sale for the ultimate benefit to the heirs. Of course, there can be significant income tax costs associated with a sale during life. It may be prudent to designate a special executor under the will with the right expertise to oversee the sale of the collection and maximize its value for the heirs after the owner’s death.
Communication and Planning Are Essential
When it comes to parting with a treasured collection, it’s important to communicate with the family early on to assess their interest in keeping the collection intact and to try to treat family members as fairly as possible. Careful planning will help mitigate estate and gift taxes that might apply, as well as to provide for the safekeeping of the collection.
Carol Kroch is managing director, wealth and philanthropic planning, Wilmington Trust Company.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.