Collecting Fine Art is a methodical personal tribute to a particular artist, to an idea or to a whimsey and can be a major part of a person’s life pursuits. Collections, however, can be pricey. Deloitte estimates that 400,000 collectors in the top wealth segments hold $1.6 trillion in art assets in private collections (1)
Before exploring your client’s collection, the financial or legal advisor must know and appreciate both the collector’s efforts and the collection itself. They are often a sizeable part of the collector’s identity. Without acknowledged respect for the collection, the collector might feel discounted or misunderstood.
Importantly, without recognizing the collection’s real value, a major segment of the client’s wealth may be left on the table. According to the IRS, the definition of collectibles includes works of art, rugs, antiques, any metal or gem (with exceptions), any stamp or coin (with exceptions), valuable alcoholic beverages or “any other tangible personal property that the IRS determines is a “collectible” under IRC Section 408(m)”.
As a professional, there are two significant stages to be addressed by the legal and/or financial advisor:
- During the active collecting phase: What is appropriate Insurance and how to use the assets for financing leverage; and
- While designing a plan for end-of-life exigences including, estate tax, distribution, and legacy considerations.
INSURANCE: During the accessioning period collectors must be advised regarding establishing a proper theft and fire insurance program which separates and lists the collectibles individually. “Umbrella” policies often have individual item limits for any items not listed and valued separately. Once the collection is initially insured the collector must continue to upgrade and maintain the valuations on a timely basis. Unless there is some stunning occurrence that momentarily and significantly revalues an artist or a collectible category, every four to five years is suggested as the appropriate length of time between re-valuations.
It is important to note that Insurance valuation is based on the cost to replace the item which typically generates the highest value ascribed to an item and is often twice that of fair market value (FMV) which is used for estate tax and donation purposes.
FINANCIAL LEVERAGING:
Those with wealth have always found ways and reasons to monetize their non cash assets. Non-cash assets have occasionally acted as a potential fallback to protect savings. Now, in that same light, the fine art, the memorabilia and the no longer fashionable jewelry, can all be used by the financial planner to create additional fiscal resources for the collector.
A collection can be used to collateralize financing in order to enlarge the collection or for any other unrelated or business use. The collectors, and by extension, their advisors, must be aware of companies such as Sotheby’s and some specialty finance firms, such as Art Finance Partners and some U.S. banks, that have been in the business of offering loans to art collectors for years.
This is an area of financial planning wherein rather than selling stock, borrowers can use art or other rare items from their collections, as collateral. It’s a way for people with high-priced art to convert what is normally seen as illiquid assets into immediate cash. The typical borrowing charges levied are interest rates of 1.85 per cent a month, or about 22.2 per cent a year, similar to some credit-card rates. These loan rates can vary depending on the size, context and quality of the collection. Terms are usually 12, 18 or 24 months. Typically, loans are for up to 50 per cent of the value of a piece. While using art as collateral is a good way for collectors to access cash quickly, the collector must be aware that he or she has assigned at least a partial interest in the piece to the lender and If the investment goes poorly, the collector no longer has full title to that piece.
As another a caveat to this process, it should be noted that all too often a collector sees their collectible in a light different from that of the lending officers. In behavioral finance, the endowment effect describes the process by which an individual values something which they already own far more than something entirely similar that they do not own. Much to their chagrin, the market may not cast quite the same bright light on the object as they imagine it deserves. This is sometimes referred to as divestiture aversion (2), in which there is seemingly greater value purely because the individual owns the object in question.
PLANNING FOR END-OF-LIFE EXIGENCES
As people age, they tend to think about shifting priorities, down-sizing and/or leaving a legacy. De-accessioning a collection can be exciting or painful, depending on the level of attachment and/or the newly discovered appraised value of the collection. If it has been a while since the collection was valued, the collector can be in for a big surprise!
The role of the financial or legal consultant at this stage is to guide the collector through decisions regarding de-accessioning. Given that few children are interested in keeping the collection as a whole, most collectors will need to either sell or donate their cherished items. Some people have clarity, such as a desire to donate a collection of religious art to their local church. Many collectors, however, have no idea of what they want to do with their collection.
SELLING: If the goal is deaccessioning, finding the right buyer or selling representative is always key. A careful study of art appraisers, brokers and consultants, including those connected to major galleries and auction houses, will establish a source for processing the proper sale point. These experts will advise the collector regarding offering the items through private and public placement outlets, timing and marketing of the sale.
If a personal referral source is unavailable it would be appropriate to seek information by contacting the offices of; The Appraisers Association of America, The American Society of Appraisers or The International Society of Appraisers. Here advisors will find Individuals, not necessarily associated with a particular outlet but rather with experience relating to multiple marketing resources.
Another alternative to consider, is on-line auctions. Of late, many art collectors are going online and using social platforms to stay at the forefront of the art market. This new route for selling art work is not just for the small investor. Sales of major works of art are transpiring via the internet.
DONATING:
When it comes to passing along their passionate pursuit to the next generation, 58 percent of art collectors are worried their heirs won’t know how to care for the collection and 57 percent are concerned about taxes when passing on their wealth to the next generation. Donation may be the best advice for these collectors.
In an advising role, presenting the idea of sharing the collections that their children and heirs may have little or no interest in, and still not having them fade into obsolescence, can be the spark that may prompt a substantial donation while freeing an estate of the financial burden required to pay onerous estate taxes.
As a reminder, for donation and estate tax purposes, Treasury Regulations Section 25.2512-1 defines FMV (the deductible amount for donation) as the gross value, inclusive of all fees and sales commissions which is usually half of the insurance value or cost to openly buy the piece. This detail is an important piece of information to share with the collector, and can, once again, generate disappointment. Collectors, as noted throughout this article, tend to highly prize their life’s pursuit.
A prominent client, finding his children less than excited about the ownership of a 300-pound Remington from his western bronze sculpture collection, presented his alma-mater with a hefty pre-endowment gift.
LEGACY:
Other than donation, the collector can distribute the collectible personal property by leaving the assets to their heirs. If this approach is taken, then care should be taken as family members may have very different views about the real fair market value for collectible assets left behind. This situation may lead to delays in the settlement of an estate, fueling disagreement among heirs, or even lead to litigation. Again, professional valuation may save the day.
Equally troubling are those issues that may arise from ownership disputes and/or difficulty in liquidating rare items due to their limited marketability or reaching a value settlement for collectibles whose worth in the family is driven by sentimental narratives potentially more than the actual monetary values. Clarity through an accurate appraisal may save the day.
In conclusion, the trust and estate professional must be sensitive to this significant asset. As opposed to other items of wealth, collections may have important meaning attached to them, which can complicate discussions. Yet, it is crucial that the financial and legal advisor attend to the collection to protect it both in the collection phase as well as at the estate planning phase. Addressing the collection as a key piece of a person’s estate not only protects their wealth but acknowledges the passion that the collectors brought to their life over many years.
- Deloitte Art and Finance Report, 2016
- https://www.investopedia.com/terms/d/divestiture.asp