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Art lawyer and tax specialist Melissa Passman weighs in on the best practices for donating your art.
Donating your art to a museum or other institution entitles you to certain tax benefits, but figuring out where, when, and how to start the process can be daunting. So we’ve enlisted art lawyer and tax specialist Melissa Passman to share her seasoned expertise with Artwork Archive’s collector community.
Melissa is General Counsel for Alpine Global Management. She has a JD from UCLA and a LLM in Tax Law from NYU (where she also earned a BA in Art History). Prior to her legal studies, she worked for Gagosian Gallery in New York. Now she works with high-net-worth collectors and family offices, as well as up-and-coming artists and young nonprofits. Melissa also currently serves on the board of JOAN, an exhibition platform in LA supporting emerging and underrepresented artists. She recently helped two organizations — Artists4Democracy, an artist-led initiative to encourage art students to participate in democracy, and Cassandra Press, a radical Black Feminist publishing platform — acheive nonprofit status.
Here’s Melissa’s advice for collectors hoping to donate their art for either income tax deductions or estate tax exemptions (or both!).
Disclaimer: The following advice is informational in nature and is not a substitute for legal research or a consultation on specific matters pertaining to you or your clients. Charitable art donations and estate planning are highly nuanced fields. Always consult professional counsel before structuring gifts to charity.
Photo by Igor Miske on Unsplash
The time to start thinking about donating your art is NOW
The best time to start thinking about and coordinating your charitable art donation is as soon in the fiscal year as possible. “Don’t wait to begin the process,” says Melissa. “Due to time limits imposed by the IRS, the end of the year can become very busy for appraisers and all of the various parties involved in the donation process.” Museums and nonprofits often have multiple levels of approvals — from committees, boards, trustees, et. al. — that donations need in order to be accepted. And that can take (a lot of) time. To ensure that you’re going to hit the deadline, it’s best to start early rather than rushing at year’s end.
Get confirmation from the donee that they actually want your art collection
Don’t assume anything! “Everyone thinks they have a wonderful collection, but that doesn’t necessarily mean that a museum will want it,” says Melissa. “So it’s critical to consult with your institution of choice prior to naming it in your will or estate plan.” Establish a point of contact at the museum or institution where you want to donate and make sure your collection is aligned with their mission and values.
The IRS also has stipulations that forbid the receiving institution from reselling the artwork within three years, unless it goes to another nonprofit organization. So, if the organization that you donate to, turns around and sells the work at auction to a private individual in two years, your income tax deduction may be seriously reduced or totally revoked. Consequently, it’s wise to stipulate in the donation agreement that the receiving institution agrees not to sell the work for at least three years, especially for gifts in excess of $5,000.
Get an official “qualified” appraisal
You will need an official appraisal to determine the fair market value of your collection for all gifts in excess of $5,000. Find a qualified appraiser who is a certified member of one of the following groups: Appraisers Association of America (AAA), American Society of Appraisers (ASA), The International Society of Appraisers. Appraisers usually charge an hourly rate, so the cost for their services will depend on how many artworks you are having appraised at one time.
If your artwork appraisal (and claimed deduction) reaches $20,000, then you must attach the actual appraisal report to your form reporting the deduction to the IRS. The IRS has an art advisory panel that will sometimes be brought in to substantiate whether an appraised value is actually correct or not. Sometimes appraisals for estates might seem disproportionately low, while appraisals for income tax deductions may appear higher than market value, leading to an audit by said IRS panel.
This is why a qualified appraiser is so important. Appraisers that have been qualified by professional appraisal organizations are bound by strict ethical standards and provide an objective 3rd-party valuation that can protect you from an overzealous IRS audit.
Important to note: the IRS requires that qualified appraisals be dated no earlier than 60 days before the date of the contribution and no later than the due date of the tax return reporting the contribution. This is why the end of the year is the worst time to start shopping for appraisers.
Some institutions are more favorable than others
Definitely consider the identity of the organization that you want to donate to, as not all charities are created equal (especially in the eyes of the IRS). In terms of “related use requirements,” it’s important to establish that the donee will be able to “use” the gift as intended. For example, donating art to a hospital might not result in the full deduction, because a hospital may not “use the art” in a manner deemed appropriate by the IRS. Therefore, it’s always recommended to consult a professional attorney before promising any charitable gifts of fine art.
When it comes to 501(c)(3) organizations, there are three main categories, each with their own advantages:
Public charities: To qualify as a public charity, an organization must receive one-third of their operating income from public donations, showing that they have a broad base of support for their programs and initiatives. Public donations can come from individuals, businesses or other grant-making organizations.
Donations to public charities by collectors can be tax-deductible to the individual donor up to 60% of the donor’s income for cash donations and 30% of income for the fair market value of capital assets, while corporate limits are generally 10%. These organizations are also required to have a board composed primarily of independent individuals. (source)
Private operating foundations: This is a form of hybrid-institution, in that its donation deductibility resembles a public charity, while its governance structure is more similar to that of a private, non-operating foundation. These foundations manage active programs and most of their earnings go back into their operations and programming.
Private foundations / non-operating foundations: Single-family foundations are examples of private foundations, which are also referred to as “non-operating foundations” and therefore typically do not have active programming. Donations to private foundations of artwork by a collector can be tax-deductible to the individual donor up to 20% of the donor’s income based on the fair market value of the artwork.
While these types of foundations have stricter rules on governance than public charities, they offer more control and so may be favored by some estates. However, because the IRS doesn’t want wealthy families to simply open a private non-operating foundation in order to hoard intergenerational wealth, these types of foundations are expected to comply with an annual 5% distribution rule. This rule stipulates that 5% of the total value of the endowment’s assets must be distributed by the organization as charitable donations, annually.
Donating art at home vs. abroad
If you donate to a non-US institution, you can still claim an estate tax charitable deduction. To claim an income tax deduction, however, the institution must be based in the US. Many international museums have set up “Friends of….” charities (i.e. American Friends of the Centre Pompidou), in order to circumvent this rule. By creating a U.S.-based foundation that can accept donations, American donors can claim (and receive) an income tax deduction even when the parent organization is located overseas.
Consider state-by-state sales tax laws
Certain states have very favorable laws when it comes to sales tax on artwork. In other states, not so much. If you’re not compliant with state sales tax laws on your art purchases, you could end up owing a lot more than anticipated, so staying up-to-date is recommended.
Due to the proliferation of e-commerce and direct-to-consumer online businesses, for example, the rules are changing and sellers may be required to collect sales tax on out-of-state sales. A 2018 Supreme Court Ruling, known collegiately as the Wayfair ruling, determined that “states can mandate that businesses without a physical presence in a state with more than 200 transactions or $100,000 in-state sales collect and remit sales taxes on transactions in the state.”(source) Each state determines its own rules.
Five states currently have no sales or use tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. Delaware has a “freeport,” but shipping art there to avoid sales tax is dicey. Art that is sitting in storage is not being “used” properly or there may be a question about intent, and thus could be the subject of a use tax equivalent to the property’s sales tax.
California has a “90-day” rule which stipulates: if an artwork spends 90-days out-of-state as a loan to an institution or is otherwise displayed (and is “being used” properly), then the owner pays no California sales tax. Sales tax in California is notoriously high (10.25% in Santa Monica) so collectors in CA have been looking to Oregon where they can, theoretically, loan an artwork to a museum group show before shipping it back to their residence, sales tax-free, after the 90-day threshold.
New York has perhaps the most complicated regulations when it comes to sales tax and art; not surprising, since New York City is arguably the center of the art world. Collectors who own a residence in New York are subject to sales and use tax on art bought from New York galleries and auction houses, even if they spend the majority of their time elsewhere (unless their New York residence is being rented out).
In New York, art shippers are not considered “common carriers” and therefore galleries and auction houses must coordinate all shipping quotes for the buyer. Gagosian Gallery was in hot water a few years ago for this very reason, ultimately agreeing to pay $4.5 million in back taxes. (source)
New York is also cracking down on resale certificates, in which a buyer may claim to be a dealer and claim a sales tax exemption, only to hang the work in their apartment for their own enjoyment. In November 2020, Sotheby’s was fined for not collecting sales tax on $27 million of art sales to a buyer who had knowingly misrepresented himself as a dealer. (source)
Ultimately, the auction house was on the hook for the back taxes. In response, however, art galleries and auction houses are now including an indemnity clause in their sales agreements, which stipulate that the buyer is responsible for remitting sales tax (and the seller is indemnified from tax liability).
The question here boils down to intent: if you’re not an actual dealer and therefore not truly intending to resell the artwork, then you’re not eligible for the deduction. Simple as that.
Beware the seeming quid-pro-quo
“The IRS doesn’t like quid pro quos,” says Melissa, “so if a donation appears to be more ‘pay to play’ than a true act of charity, they could revoke your tax deduction.” Collectors buying sought-after artists from blue-chip galleries are sometimes asked to donate art as a condition of sale: i.e. “If you want this painting by artist X, then you also have to buy this painting by artist Y and donate it to a museum.” The IRS is apparently wise to this sales strategy, so caveat emptor.
Limit restrictions on your donation
In terms of estates, Melissa explains that if a donation has “too many strings attached,” the IRS will not consider it a true donation and the owner will lose their exemption. “The question is, did you sufficiently give up control?” she says.
If the agreement contains a clause, for example, stating that “X and Y condition must be met, or else the museum is required to return the work,” that could be interpreted by the IRS as too many restrictions. In other words, “how remote is the possibility that the work will revert back to the donor?” explains Melissa. She also emphasizes that, as long as the work stays with the museum, it’s okay to add a few conditions, such as exhibition clauses.
Still, many institutions have their own regulations, such as the MoMA in New York. "All gifts have to be unconditional," according to MoMA Director Glenn D. Lowry, before they will be considered for acceptance. As noted by The Planned Giving Design Center on their website, “This is standard practice for many museums.” (source)
Use it or lose it
The estate tax exemption ceiling is not fixed and is subject to change. The current individual exemption limit is $11.7 million (for 2021), but based on the 2017 federal tax legislation, that ceiling will lower to around $5 million (adjusted for inflation) in 2025. This means that 2021 is still a time when people can still use the higher exemption ceiling, ensuring that their heirs get a maximum credit, and they should. Because, as Melissa emphasizes, “the estate exemption really is a ‘use it or lose it’ situation.”