United States

Valuation discounts for artwork and collectibles–a taxpayer victory


Many individuals utilize valuation discounts for gifts and bequests as a key planning strategy. A common approach involves the use of both minority and lack of marketability discounts to reduce the value of a taxable gift, which can result in profound transfer tax savings. However, a critical issue arises when using valuation discounts with artwork and collectibles. On one hand, these are certainly special assets that usually require a qualified appraisal to determine fair market value. However, should these assets be offered the same type of discounts as closely held businesses so as to reduce the underlying estate or gift tax liability? 

According to the Fifth Circuit, the answer is a resounding "yes." In Elkins v. Commissioner, the Fifth Circuit ruled that valuation discounts are available for gifts of a fractional ownership of artwork (Estate of James A. Elkins, Jr. v. Commissioner (case no.13-60472, 5th Circuit,  2014). In this case, the decedent and his children owned fractional interests in 64 works of art subject to a co-tenants agreement. The estate held a 73 percent interest in the artwork under the agreement, and the agreement required the unanimous consent of all co-tenants to sell any item. The estate took a 44.75 percent valuation discount on its estate tax return for its interest in this co-tenant's agreement. 

The Tax Court disallowed the 44.75 percent discount because the decedent's children had both the desire and the financial means to own the collection outright. As such, the discount was deemed too high, and the Tax Court allowed a modest 10 percent discount. The Fifth Circuit reinstated the original discount because the IRS asserted that a discount should never have existed. The Fifth Circuit ruled that the estate was entitled to take this discount and further ruled that since the IRS had never made an argument to lower this discount, the estate was entitled to the 44.75 percent discount reflected on the return. In essence, the taxpayer prevailed because the IRS pursued the wrong tax position. If the IRS had acknowledged the availability of the valuation discount and argued for a much lower discount rate, there would have been an excellent chance that the IRS would have prevailed.

There are a couple of lessons to learn with respect to this case. First, Elkins should be considered a win for taxpayers pursuing discounts for special assets such as these. However, the second lesson is that this success should be tempered with an understanding that the IRS can prevail on lowering discount percentages unless the planning is done carefully. For taxpayers and their advisors, this means ensuring that these special assets are placed in entities that can best promote valuation discounts, such as very restrictive family limited partnerships or limited liability companies. These entities need a valid economic or business purpose to prevent a "form over substance"argument. Finally, the discounts should be fully supported through the use of a qualified appraisal. Although there are never any guarantees that valuations will not be challenged, at least proper due diligence will have been implemented to best protect these values and the transfer tax savings associated with them.


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