Appraisals are, of course, a key component of the art lending process. Art loan collateral is appraised on an annual basis — less frequently than other collateral types — making art loans a way to help reduce margin call risk in times of market volatility. When obtaining an appraisal, keep in mind that there are four different values for every object, depending on the appraisal’s intended use: retail replacement, fair market value, marketable cash value and auction estimates. Be sure you’re using the right one for your purposes, whether they be lending, insurance, planning or gifting.
Appraisal firms have adjusted to operating within the logical constraints presented by the pandemic and continue to provide updated appraisals by viewing works via digital images, videoconferencing and, when appropriate, in-person site visits. And because appraisals are primarily based on past comparable sales, we’re not seeing the so-called “COVID discount” that some collectors have been expecting.
More museums selling works
The pandemic has seen a marked uptick in museums selling art from their collections. A temporary policy shift (effective through 2022) by the Association of Art Museum Directors (AAMD) allows for proceeds from deaccessions to be used for “expenses associated with the direct care of collections,” whereas pre-pandemic, they could only be used for acquiring more art.
Even with the loosening of restrictions, museum deaccessioning can result in controversy. This year, the Brooklyn Museum announced that it would sell 12 works to establish a $40 million fund for collection care, which was approved by the board and curators. By contrast, the Baltimore Museum of Art’s deaccession announcement was met with pledge withdrawals, board resignations and a petition to the state government to block the three sales.
Many museums are looking for redundancy in their collections to fund collection care and/or to rebalance their collections with underrepresented artists. Although deaccessioning can be a solution for some institutions, leadership should have a strategy to manage several key risks in the process:
|Donor and board sentiment
|Major gift pledges
|Donations, sponsorship, visitorship
|Art sale process
|AAMD policy parameters
|Compliance with gift acceptance policy
Our recommendation: Don’t go it alone. Institutions will be best served by working closely with their trusted team of advisors—including fiduciaries, philanthropic advisors, art professionals and legal counsel—to help them navigate this complex, multifaceted process.
Collection management. 2020 saw an acceleration of individuals moving from high-tax states to low- or no-tax states. This movement also reflects a concern about the coronavirus and social unrest in more densely populated areas. Collectors who are considering such a move should ensure that they engage collection management specialists to assist with the movement of their collections — from packing, to moving, to re-installation — as well as appropriate insurance coverage along the way.
Sales and use tax. Collectors should consult with their legal and tax advisors to ensure compliance with change of residency requirements, not only for income tax purposes but also for sales and use tax purposes. For example, if collectors move to a state with no income tax, and buy art and put it on the walls of their new home, they should be aware that the sales or use tax in their new state could be significant. Remember: Each state has different rules on mitigating the sales and use tax (for example, exemptions or a number of days of “first use”), and storage of art at free ports does not get you out of state sales and use taxes.
Planning and potential tax changes. Now that the 2020 election is behind us, what should collectors be thinking about when planning for the ultimate disposition of their collection? The Biden administration has proposed a number of tax changes that may affect collectors. Whether any or all of these are enacted, and whether they’ll be retroactive to the beginning of 2021, remains to be seen. These are the issues that collectors should be exploring with their tax attorneys:
1. Income tax. Increase of the top ordinary income tax rate from 37% to 39.6%. A sale of art held for a year or less would be taxed at 39.6%, plus the 3.8% Medicare surtax, for a total federal tax rate on gain of 43.4% for taxpayers with income of $400,000 or more. Add any state income taxes to that.
2. Capital gains tax rate. Increase of the federal long-term capital gains tax rate from 28% to 39.6% for taxpayers with $1 million of income or more. Add the 3.8% Medicare surtax, and the federal tax rate jumps from 31.8% to 43.4%.
3. Estate and gift tax exemption reduction and tax rate increase. The current estate and gift tax exemption of $11,700,000 per person is scheduled to decrease to $5 million (indexed for inflation) on January 1, 2026. A Democratic unified government might accelerate that decrease to 2021 or 2022. Additionally, the current 40% gift and estate tax rate may also be increased.
4. Restrictions on valuation discounts. Many planning techniques are structured to use valuation discounts. Under the Obama administration, the Treasury issued proposed regulations that would restrict the use of such discounts; those regulations were withdrawn by the Trump administration, but the Biden administration might reinstate the proposed regulations.
5. Elimination of basis step-up. Under current law, the basis of assets is stepped up to fair market value at death, and the decedent’s heirs only recognize gain on post death appreciation. The Biden administration has proposed: (1) carryover of the decedent’s basis to the heirs; (2) the decedent’s estate would owe capital gains taxes on appreciated assets purchased during the decedent’s lifetime at the time of the decedent’s death; and (3) a gift of appreciated assets during life would result in capital gains tax at the time of the gift. Any or all of these proposals could increase and/or accelerate capital gains tax liability and affect wealth transfer planning.
6. Charitable income tax deductions. Some good news! The increased charitable income tax deduction of up to 100% of a donor’s adjusted gross income (AGI) passed as part of the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") has been extended into 2021. This applies only to cash gifts made to public charities (not a donor-advised fund or private foundation), and does not apply to donations of works of art; in which case the income tax charitable deduction is limited to 20% of donor’s AGI for works donated to a public charity.
In 2021, the art world continues its evolution through an unprecedented period of transition and innovation. Bank of America Art Services looks forward to helping you navigate the market as the new art ecosystem emerges post-pandemic.