Collectibles, Art and Estate Planning
What is a collectible?
According to the IRS, the definition of collectibles generally includes works of art, rugs, antiques, any metal or gem, any stamp or coin, valuable alcoholic beverages or any other tangible personal property that the IRS determines is a “collectible” under IRC Section 408(m), subject to exceptions.
There are two common ways to distribute collectible personal property: leave the assets to your heirs or donate them to a charitable organization. Either way, special tax and estate laws will apply. Ignoring these laws can result in unnecessarily high capital gains taxes to your heirs, income or estate tax penalties, or depreciation of the asset’s market value.
Issues may arise from ownership disputes, or liquidation difficulties, assets with limited market demand or collectibles with primarily family sentimental value but no monetary worth. These issues can lead to delays in the settlement of an estate or even litigation, all of which can be very costly. One way to reduce the chance of this is to obtain appraisals for all valuable collectibles during your life. Remember that even if your heirs choose to keep the assets rather than sell them, they will still need a value of all assets to establish the total value of your estate. If assets are not sold within a period of time of the owner’s death, or if values exceed a certain level, the estate must obtain an official appraisal for valuation purposes. Note that valuation for insurance purposes is not the same as valuation for estate planning and legacy purposes!
How are collectibles taxed?
Reliable valuation from qualified expert appraisers (as determined by IRC 170(f)(11)(E)) is also necessary to satisfy income and estate tax laws. Appraisal done as of the date of death provides an accurate tax basis (“stepped up” basis) that the beneficiary will take on when the asset is distributed to them. This determines the taxable gain and income tax that beneficiaries will pay if they hold assets for a period of time then sell them. When collectible assets are held for at least one year by an investor (i.e., a beneficiary who is not acting as a dealer in that type of asset), long-term capital gains tax rates apply, (28% of your adjusted gross income).
This may incentivize you to keep highly appreciated assets until you die to reduce the overall capital gains tax that you or your heirs would have to pay. You would also need to consider whether keeping the asset would increase your estate valuation, creating unwanted estate tax liability. Remember that basis calculations can also work in reverse, meaning there could be a “step down” in tax basis if the value of the asset at the time of inheritance is lower than the original price paid.
Another disadvantage for higher income beneficiaries is that sale of collectibles held less than one year are taxed at ordinary income tax rates. If you inherit a collectible and later sell it at a loss (compared to the basis you receive), your ability to write off such loss will depend on evidence of “personal use.” For example, if you inherit a valuable piece of artwork, hang it in your home then sell it at a loss, the IRS may reduce or eliminate the amount of deductible loss, whereas if a collectible is held strictly for investment purposes, then the loss is usually deductible. Contact a CPA or estate tax attorney who can help you determine if inherited collectibles are likely to be treated as personal use or investment property.
Four tips to improve settlement of collectibles upon your death:
Appraise. Obtain one or more appraisals from certified experts, including a certificate of authenticity for high value and rare items.
Inventory. Keep records and inventory of purchase date, price, appraisals, damages, insurance coverages and cost of any improvements such as refurbishment or repairs. For collections, consider making a list of all the individual items in the collection and record the above information for each piece in the collection. You may also want to include selling dates for items of a collection and the names of past buyers and sellers as they may serve as a ready market for the collection.
Gift. Consider taking advantage of annual or lifetime gift exclusions by gifting personal property during your lifetime.
Discuss. Talk to your family about the items and who wants them to dissuade disagreement later. Make sure any promises to pass down certain items to a particular person are clearly written in your estate plan. Also notify your investment adviser, CPA and estate planning attorney of collectibles that may have value.