How to Protect Art Collections from Gift and Estate Tax Exposure by Lewis Kevelson, CPA
Posted on October 03, 2023
by
Lewis Kevelson
According to a recent study by Art Basel and UBS, global art sales in 2022 exceeded pre-pandemic levels, reaching $67.8 billion in transactions. Buyers, ranging from high-end collectors to Gen Xers and Millennials, increasingly recognize art’s value as an alternative investment in a fragile economic and geopolitical environment. However, as buyers grow their collections, they must take the time to consider how rising values will impact their tax exposure, especially with the estate tax exemption set to be cut in half in 2026.
Understanding Estate and Gift Tax Exemptions
Under current U.S. tax laws, individuals have a generous federal lifetime gift and estate tax exemption of $12.92 million, or $25.84 million for married couples filing joint tax returns. Barring any legislative action, these thresholds are set to expire in 2026 and revert to their pre-2018 levels of approximately $5 million for individuals and $10 million for married couples, adjusted for inflation.
The tax code also offers individuals a separate annual gift tax exclusion that allows annual tax-free gifts of up to $17,000 (or $34,000 for married couples) to as many beneficiaries as one chooses. Making annual gifts up to these limits remove assets from one’s taxable estate, excluding them from their lifetime gift and estate tax exemptions and reducing their exposure to federal and state inheritance tax at death. With this in mind, it behooves individuals with a substantial art collection to consider the estate planning benefits of donating artwork to charity or gifting highly appreciated work to heirs during their lifetime.
Using an LLC to Hold Art
A limited liability company (LLC) is a legal structure families can create to hold highly appreciated assets and pass them to heirs with reduced estate and gift tax implications. This structure provides certain advantages, such as protection from certain liabilities and bad marriages. For income tax purposes, LLCs are treated as flow-through entities that pass all items of income, capital gains, capital losses, credits and deductions to its members who pay federal income tax on their share of the LLCs profits at their individual tax rates.
LLCs also allow senior family members to maintain control over the collections they carefully curate, including any decisions to sell or add new pieces, withdraw funds or transfer shares to the next generation. In fact, gifts or sales of non-voting LLC interests to the next generation should qualify for valuation discounts due to their lack of voting control and marketability. These discounts further enable senior family members to remove assets from their taxable estates in a tax-favored manner.
As an example, consider a married couple who establishes an LLC to hold an art collection with a fair market value of $10 million (based on a valuation from a qualified art appraiser). A $1 million transfer of non-voting interests to a family member (or trust) may qualify for a discount based on the terms of the LLC operating agreement. Assuming a 40 percent valuation discount, the membership interests would be valued for gift tax reporting at $600,000, and the parents would utilize their lifetime gift tax exemption as a credit against the gift tax. Future planning would call for the senior family members to loan cash to the LLC to support future art purchases. The senior family members would take back a promissory note in exchange for the loan with favorable repayment terms. The LLC would acquire the artwork that would position it for future appreciation without exposing the senior family members to additional estate or gift tax exposure. For an added layer of protection and potential tax savings, the parents also may consider forming one or more dynasty trusts to hold the gifted LLC interests.
About the Author: Lewis Kevelson, CPA, is a director with Berkowitz Pollack Brant’s International Tax practice, where he helps high-net-worth families, entrepreneurs and business owners structure transactions to comply with domestic and international tax matters while building and preserving wealth. He can be reached at the firm’s West Palm Beach, Fla., office at (561) 361-2050 or info@bpbcpa.com.
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