Valuing Artwork For Federal Taxation Purposes: Income, Estate & Gift Tax Issues

Valuing Artwork for Federal Taxation Purposes: Income, Estate & Gift Tax Issues1

Introduction

Valuing artwork is inherently subjective. Appraisers can rely on objective factors to value artwork, such as comparable sales of similar pieces, but, clearly, two different appraisers can arrive at different values. There may also be a variety of subjective factors that affect the value an owner ascribes to a particular work of art, whether it is because the work is a family heirloom or because the work was recovered from the Nazis. On top of all this, the tax rules often motivate owners to overvalue or undervalue property, including artwork. The Internal Revenue Code of 1986, as amended (the "Code"), and the Treasury Regulations thereunder, establish a labyrinth of rules and requirements regarding the taxpayer's burden to substantiate the value of property stated on a tax return. For federal tax purposes, the importance of valuing property is apparent in three common scenarios: (1) when an owner donates property to a charitable organization and wishes to claim a charitable contribution deduction under Section 170, (2) when a decedent's gross estate is valued for the purpose of calculating the estate tax, and (3) when a donor is subject to the gift tax under Section 2501.

The Code incentivizes taxpayers to choose a higher valuation for artwork in the case of a charitable contribution and a lower valuation in the case of the estate or gift tax. What is an owner to do if one appraiser values a work at $25 million, while another values it at $30 million? Considering that the highest individual income tax rate is currently 39.6% and the highest estate and gift tax rate is 40%, a taxpayer's preference for a low-side or high-side valuation of artwork may affect his tax liability by millions of dollars. The tax law makes clear that the taxpayer has the burden of substantiating the value of the property. To this end, a taxpayer must not only comply with the procedural requirements for valuation, but must also persuade the trier of fact that his claimed valuation is correct.

What Is "Fair-Market Value" for Federal Tax Purposes?

The Treasury Regulations define "fair market value" as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts."2 Although this "willing buyer" and "willing seller" approach appears workable, the parties involved in a donation or gift, for example, are not forced to agree on a negotiated value the way an actual buyer and seller are. Accordingly, the only obstacle to using a particular valuation for artwork is often the Internal Revenue Service (the "IRS"), combined with the potential for penalties and interest in the case of a misstatement of value. In an effort to assist taxpayers in valuing artwork, the IRS established the Art Appraisal Services division (the "AAS"). Prior to submitting an income, gift, or estate tax return, a taxpayer can request that the AAS provide a Statement of Value in which the IRS values the artwork for the taxpayer. A...