Collectibles, such as art, wine, jewelry, and coins and stamps, have long been important assets to individuals, particularly high-net-worth individuals. Art collectors say that the emotional value of buying is their key motivation, but investment return, inflation hedging, and asset diversification are also important considerations, according to findings from Deloitte (“Seeing the Bigger Picture: Arts Collectibles, and Wealth Management,” 2014, http://bit.ly/2l03B5k). Owning collectibles raises a number of financial and tax issues that financial advisors should address with individuals.
Investment issues aside, there are two main risks to collectibles: theft and damage resulting from fires, storms, and other such events.
Keeping collectibles as free as possible from breakage, water damage, and other physical destruction is essential for maintaining their value. Items should be kept where temperature can be maintained and humidity avoided. Depending on the nature of the item, proper storage in plastic bins and sealed bags can protect against water damage.
Collectors should not assume that their basic homeowners/renters policy covers their valuables. Usually, these policies have limits on what can be covered (e.g., up to $1,000 for jewelry, $2,500 for silver). They may also exclude entirely any coverage for artworks, coin collections, and certain other collectibles. It is essential to review existing policies for the extent of coverage and, if necessary, supplement it with riders or separate coverage for collectibles. Usually, the premiums for these separate policies are based on a dollar amount per value of items covered; thus, appraisals or receipts are necessary to include items in the policy.
Guarding against theft is an important consideration for valuable collectibles. Home security systems provide protection, as well as a reduction on premiums for insurance policies. Storage in a safety deposit box is a good option for certain collectibles, such as coins and jewelry. Be sure to check whether existing insurance policies cover theft or damage of items stored in a safety deposit box or whether a rider or separate policy is necessary.
Holding Collectibles in IRAs
While an individual may view owning collectibles as a good financial strategy, IRAs are barred from investing in collectibles. If such an investment is made, the amount invested is treated as having been distributed to the owner in the year invested; this results in immediate taxation, as well as a 10% early distribution penalty if the IRA owner is under age 59½. The IRS lists the following as collectibles: artworks, rugs, antiques, metal, gems, stamps, coins, alcoholic beverages, and “certain other tangible property.” While the IRS has not enumerated any examples of this other tangible personal property, it could include antique cars, books, historic memorabilia, and sports memorabilia.
There are some exceptions to the items listed above. An IRA can invest in one-, one half–, one quarter–, or one tenth–ounce U.S. gold coins or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.
What about bitcoins and other cryptocurrency? The answer is unclear. The IRS has said that bitcoins will be treated as property and not as currency (Notice 2014-21, http://bit.ly/2C5pFzq), but it has not said whether it is viewed as a collectible. There are a number of self-directed IRA custodians offering this investment option, but it is advisable to proceed cautiously in this regard until the IRS has spoken.
Selling collectibles is not always easy. Depending on the type of item and whether it is part of a collection, auctions through reputable houses are often the method of choice for selling collectibles. The process can take time because sales for certain types of items (e.g., antique jewelry, Native American art) may be held only a few times per year. In addition, there are usually significant costs involved for the seller, including a seller’s premium (a percentage of the sale price) and other fees (e.g., photography, insurance, shipping).
From a tax perspective, the tax rate on the capital gain on the sale of a collectible can be higher than the usual capital gain rate. For federal income tax purposes, the rate is up to 28% on collectibles gain; that is, gain from the sale or exchange of a work of art, rug, antique, metal (e.g., gold, silver, or platinum bullion), gem, stamp, coin, or alcoholic beverage held more than one year. Collectibles gain also includes gain from the sale of an interest in a partnership, S corporation, or trust due to unrealized appreciation of collectibles. If collectibles are purchased and then sold in a year or less, it results in short-term capital gain.
Of course, not all collectibles appreciate in value. Unfortunately, items may be sold for less than their cost, resulting in a capital loss.
Giving Items Away during Life
Depending on the items, it may be desirable to donate them to a museum or other tax-exempt organization. If the items are to be used in the organization’s exempt purpose and have been held for more than one year, then a charitable contribution deduction can be claimed for their fair market value. Considerations for donating items include the following:
- The charity may require additional cash donations before accepting an item in order to take care of it. Discuss proposed donations to find out what is required.
- It is essential to obtain a qualified appraisal and, where required, attach it to the donor’s tax return [Internal Revenue Code (IRC) section 170(f)(11)(E)]. If appraisals result in overvaluations, there is a 20% penalty for a substantially understatement of income tax; this can rise to 40% [IRC section 6662(d)]. Note that the IRS has an Art Advisory Panel made up of 25 renowned art experts to review and evaluate property appraisals submitted by a donor. A donor can request a review by the Art Advisory Panel of art valuations for items appraised at $50,000 or more. The Statement of Value received by the panel is then attached to the return and will not be challenged by the IRS. There is a user fee of $5,700 for one to three items, and $290 for each additional item (the fee may be increased annually).
- The donor may not be able to fully benefit from a tax deduction. There is an adjusted gross income (AGI) limitation of 30% (20% for certain private foundations) for items used in the organization’s exempt purpose (e.g., a painting donated to a college that students use in art study classes). Unused deductions can be carried forward for up to five years. The itemized deduction is also reduced by as much as 80% for high-income taxpayers (unless pending legislation eliminates this phaseout). The cost of an appraisal may be deducted as a miscellaneous itemized deduction, but most high-income taxpayers cannot benefit from this write-off because of the 2%-of-AGI floor.
It is essential to review existing policies for the extent of coverage and, if necessary, supplement it with riders or separate coverage for collectibles.
Again, advisors must be sure that the donor knows what the organization will do with the collectible. If the item’s value exceeds $5,000 and the organization disposes of it within three years of the donation, there is income recapture to the donor [IRC section 170(e)(7)] in the amount of the excess of the deduction over the donor’s basis in the property at the time of the donation. Recapture can be avoided by having the organization certify in writing that the use of the item was substantial and related to its exempt purpose; or, if not substantial, it was disposed of because its intended use had become infeasible or impossible to implement [IRC section 170(e)(7)(D)].
Instead of an outright donation, individuals can consider a bargain sale. This is a sale to the charity for less than the item’s fair market value. Typically, the donor recoups the investment in the collectible and claims a deduction for the difference between the sale price and the fair market value.
Gifts through trusts.
Collectibles can be given to charities through a charitable remainder trust (CRT, which entitles the donor to enjoy the items during his lifetime). The charity receives the items when the donor dies; the donor receives a current income tax deduction for the present value of the charity’s remainder interest. CRTs are, however, complicated arrangements that should only be used after discussing the ramifications with a tax professional.
Gifts to family members, friends, or others.
Giving physical possession of items to someone is a gift for federal gift tax purposes. In 2017, a gift up to $14,000 ($28,000 for a married couple consenting to a joint gift), or up to $15,000 ($30,000 for a couple) in 2018, is free from federal gift tax. Larger gifts may be tax free to the extent of the donor’s lifetime exemption amount ($5.49 million in 2017; $5.6 million in 2018).
Estate Planning Concerns
What happens to collectibles after the owner’s death? Estate tax concerns include deciding what will happen to collectibles after an owner’s death and how to factor them in for estate tax purposes.
Owners must decide who will receive their assets when they die. According to a U.S. Trust report (“2017 Insights on Wealth and Worth,” http://bit.ly/2knoG5R), 79% of collectors plan to pass their art on to family members, 30% plan to donate it, and 26% intend to sell most of their collection (the percentages overlap where collectors plan to do more than one thing).
Passing items to family members.
Individuals should be sure that intended heirs want the items from an estate. Millennials do not value many of their seniors’ prized collectibles and may not want silverware, china, antique furniture, or even artwork.
A person can designate in a will or a trust the child or other relative who will inherit an item. This is usually not the best solution, however, because items may be sold and new items acquired, which makes frequent revisions to a will or trust impractical.
Where a class of heirs (e.g., the decedent’s children) inherits all personal property, a better solution may be to create a letter of instruction. This is an informal document telling heirs who gets what. The instructions should factor in the desires of the heirs for particular items; the letter should be kept up to date and tell heirs where they can find the items given to them. The existence of the letter of instruction should be communicated to the heirs to avoid a grab for assets when the owner dies.
The appraisal process for estate tax purposes is the same as for income tax purposes described above. If items are left to a qualifying charity, however, there is no cap on the amount of the deduction for estate tax purposes (IRC section 2055).
If an estate includes significant collectibles and there is an estate tax, the executor must raise capital to pay the tax due within nine months of the decedent’s death. It may not be possible to sell off items this quickly; therefore, liquidity for paying the estate tax should be provided through the sale of marketable securities, sufficient life insurance payable to the estate, or some other fashion.
The Cost of Collecting
Wealthy individuals have long been art patrons and serious collectors, and programs such as Antiques Roadshow have made many other individuals aware of the fun and financial gain that can be reaped from collectibles. All such individuals should, however, be aware of the tax, financial, and estate planning issues for their prized items.
Checklist for Collectibles
_____Has attention been given to physically protecting the items?
_____Has insurance coverage been purchased for the items?
_____Has donating items to charity been considered?
_____Is an appraiser necessary, and if so, is a reliable one known?
_____Has the disposition of the items upon death been planned for?
_____Have estate taxes on the items been planned for?