Top Tips on Valuing Art to Minimize Taxes

When it comes to estate settlement, one of the necessary steps that executors must accomplish is assigning a value to all of the assets of the deceased person. This is easy to do in most cases, as such assets as stocks, cash and real estate usually have a value that can be clearly determined by either looking at the closing market price on the date of death or having an appraiser assign a value to the property.

But assigning a value to items such as artwork can be a more difficult proposition; the factors that go into assigning a value to such pieces are often less than exact, and their exact value can be hard to pinpoint.

Read on for tips about how to find the value of art. (For related reading, see: Profit from Art with a Charitable Remainder Trust.)

The value of artwork, like all other property in an estate, is determined by ascertaining its fair market value. The IRS rules outline that the FMV of a piece of property is the price that a willing and informed buyer would pay a willing and informed seller for the item in an arm’s length transaction. This must take place in a market where this item is commonly bought and sold, with neither the buyer nor the seller facing any undue external or internal pressure to enter into the transaction. Of course, the catch with art is that all values are ultimately subjective, and the art in question may not have a readily available market in which to determine its value. 

The IRS also often gives careful attention to the methods used in valuing artwork, so filers need to be prepared to document and present their method of appraisal to the IRS in the event that they are audited. If the piece or group of art in question is worth at least $5,000, then the rules allow the IRS to challenge its value up to four years after the return has been filed. All pieces or groups that exceed this limit will require a professional appraisal anyway, so filers need to be sure to keep a copy of this with their tax records.

One of the best ways to prove the value of artwork that is bequeathed to heirs is to show comparable sales or gifts that are valued at or near the value that the executor assigns to the piece or group. The more comparable sales or gifts that can be shown, the less likely it is that the IRS will contest the valuation price. But the IRS is also aware that donors who give artwork to friends or family in order to reduce their taxable estates will most likely attempt to assign as small a valuation as possible in order to avoid gift or estate tax, while those who donate items to a qualified charity will be inclined to assign as large a value as possible in order to maximize their deductions. Therefore, an appropriate adjustment based on these comparable numbers may be necessary in order to ensure compliance with the valuation rules. (For related reading, see: Fine Art Can Be a Fine Investment and Fine Art Funds: a Beautiful Investment.)

Here are a few tips that can help you to assign a sound value to artwork in an estate.

• Artwork that can be easily sold is worth more than pieces or groups that will take longer to sell, even if the latter item is ultimately sold for a similar price. Liquidity adds value to any piece of art, regardless of the type of art or other conditions in the market.
• Executors can often assign a bulk discount to a collection of artwork if it is large enough to make it probable that it will not all be sold at once. This strategy has held up to a certain degree in tax court, but executors need to make sure that the amount of the discount is reasonable.
• Art that is sold at auction will probably go for less money than in a retail transaction such as with a gallery. Using the auction price will probably be a safe bet in most instances, because it meets the criteria of the fair market value definition. But again, executors need to make sure that the assigned value is firmly within the range of prices at the auction or gallery.
• Unfinished artwork, such as sketches or drawings or other incomplete pieces that would not be otherwise sold, can usually be appraised at a minimal value.

Appraising artwork and collectibles can be a very inexact process in many cases, and executors who are faced with this issue will need to enlist the help of qualified appraisers, auctioneers, art dealers and perhaps a tax expert who are all experienced in dealing with this issue. The IRS will not only penalize the estate or tax preparer for works that are substantially undervalued—it may go after the appraiser as well, so it is important to make sure that all valuations are realistically high. (For related reading, see: Why Should You Invest in Tangible Assets?)