COLLECTIBLES, SUCH as this Majolica wine cooler, may be treasures for us, but could mean hardship for our heirs.

Value and Validity
Joanne Johnson, a wealth advisor at JP Morgan Private Bank in New York City, recommends a practical first step: assessing the worth of our collectibles. “If your collection comprises up to 50 percent of your overall assets, but doesn’t dominate them, your concern should be focused on how to divide it up among future generations,” she says. “Problems arise when your collection is so valuable and appraises so highly that its value exceeds the liquidity of your estate on death.” In this case, say experts, directing a sale is the best and simplest solution. 

Over time, collection expenses—and the quality of the collectibles themselves—often spiral upward. But often, says Ralph Lerner, an expert in art law with the firm of Sidley Austin Brown & Wood, collectors never bother to remove older, less valuable pieces from their collections. These pieces, advises Lerner, should be sold to build a sinking fund to pay taxes or purchase insurance. Then we can move ahead to hire an attorney to work out a plan.

Indeed, one of the more difficult aspects is appraising the collectibles themselves. The key is finding a good appraiser, because the consequences of poor appraisals can be dire: severe tax penalties or forced liquidation of the collection. Appraisers should be experts who are not connected to an auction house, because they might have hidden profit motives, such as the consignment of certain pieces or even the entire collection. “Hire appraisers with no financial interest in the material and who have expertise in the specific area of your collection,” says Jane H. Willis, president of the Appraisers Association of America. Besides her organization, Willis advises that collectors consult two other nonprofit trade associations for referrals—the American Society of Appraisers and the International Society of Appraisers. These organizations have authoritative ethics committees to use as recourse if problems with an appraisal arise.

TOP VIEW Art, antiques, furniture, rarities—for many of us, our collections are the best reflection of our personal aesthetic. As such, it is often difficult to broach what will happen to these individualistic and often iconoclastic portfolios when we are gone. But with careful planning, we can ensure our collections end up where we want them—with a museum, our children or like-minded collectors—without being swept away in a torrent of gift or estate taxes.

Also, the IRS has its own stringent mechanism for appraising appraisals: the Art Advisory Panel, an oversight body comprised of 16 to 20 experts drawn from the ranks of galleries and museums. Tax returns selected for audit, typically those claiming property that exceeds $20,000 in value, are brought before this panel for review. The panel meets in Washington, D.C., once or twice a year, reviewing some 250 to 300 items at each one-day meeting. According to some experts, the IRS has cracked down on valuations lately because of uneven appraisals—donated items routinely valued at the high end and gifted ones valued at the low end. Although panel members are not told whether an item is being gifted or donated, says one former member, “it was patently obvious when people were [making donations, since they were] claiming their items were worth five to 10 times what they actually were.” 

According to James Maroney, a private art dealer in Vermont, making sure the appraisal is well documented offers some protection. Still, “the system is so hopelessly arbitrary I would say do everything you can to avoid it,” he concludes. In 2002, the panel reviewed 469 items with an aggregate taxpayer valuation of $100.4 million, on which total adjustments of $46.9 million were recommended. For items in charitable contribution claims, an average reduction of 60 percent was recommended. Conversely, for estate and gift appraisals, the average valuation increase was 88 percent. Inaccurate appraisals are not without consequence: If an object’s valuation is found to be off by more than 150 percent of its fair market value, an additional 30 percent of the tax underpayment is assessed. In this circumstance, appraisers may be subject to sanctions as well.

Elaborate Chess Game
One effective legal tool for passing on collectibles to heirs—a Chippendale highboy, for instance—is a dynastic generation-skipping trust. Such trusts bypass gift and estate taxes. They do not, however, survive more than 21 years beyond the death of the last beneficiary alive when the trust was settled—or possibly longer, depending on where it was written. 

Dynasty trusts are often initially funded during one’s lifetime by harnessing the $1 million gift tax exemption, and later by using the estate tax credit of $1.5 million for an individual or $3 million for a couple. High-value assets like the Chippendale highboy then reside inside the trust as long as the trust exists. However, since a highboy does not produce income by itself, it could be sold and the money held in the trust or distributed according to the discretion of the trustee. “[A dynasty trust] is a good vehicle in just about all circumstances,” says CPA Larry Lipoff of Perelson Weiner in New York City. “It defines succession and protects the assets against acts of malfeasance.” If a lawsuit is initiated against an individual whose assets are held in trust, the assets are virtually immune. The generation-skipping trust, a variation of the dynasty trust, can be exempt from the Generation Skipping Tax for as long as the trust exists. Any person can transfer up to $1.5 million into it without incurring the generation-skipping trust tax.

While quite effective, these trusts are not perfect. Because the assets do not produce income to pay taxes and other costs, experts suggest that collections worth less than $2 million be placed in trusts that can provide tax exemptions. Above this threshold, a collection can be donated en masse to museums. Second, the actual possession of the asset is significant—especially to the IRS. That means the collectible must be in the physical possession of the beneficiary. It also may be loaned to a museum, kept in a warehouse or even displayed in an in-home museum. It cannot, however, reside in the grantor’s own home.

Moving the property into a Family Limited Partnership (FLP) also lowers the tax consequences of a lifetime transfer of collectibles, says Jon Gallo, a senior partner with the Los Angeles-based firm Greenberg Glusker Fields Claman Machtinger & Kinsella. In an FLP, general partners control the trust, and limited partners share profits but not control. Thus, a couple may own a 1 percent interest as general partners and 99 percent as limited partners. Then they transfer the collection to the partnership. The FLP interest is an asset that can then be given to a dynasty trust, since under current gift tax law, valuation discounts are allowed. The end result: leveraging the gift tax lifetime exemption. However, one must stringently follow the rules. “One must look at the FLP assets as owned by a business that is owned by the family,” explains CPA Lipoff. “The head of the family has a fiduciary responsibility to the other family members to protect their assets.”

Jon Gallo offers this final advice: “Estate taxation is an elaborate chess game with the IRS, and if you play by the rules, you will always win in the end. The IRS simply expects you to obey the laws.” 

Photo courtesy of Marilyn G. Karmason, M.D., Majolica International Society

Additional Information
Avoiding Mistakes