Tax Benefits and Challenges of Private Museums¹July 2015 – Art & Advocacy, Volume 20
This article was updated on March 25, 2016.
Collectors who have run out of space to store or display their art at their homes inevitably confront the question of what to do with their spare art. Collectors who are considering their estate planning options might also question how their art figures into their legacy. The options typically considered are to sell, bequeath, or donate the art. This article describes a twist on the third of these options: the donation of one's art to a museum located on or near one's property, where the museum remains largely controlled by the donor and might be thought of as an extension of the donor's personal residence.
The choice between selling, bequeathing, or donating one's art is sometimes influenced by tax considerations. To illustrate how these considerations play out in real life, let's assume we have a collector who paid $10 over the years to amass a collection that today is valued at $100. Let's further assume that our collector's net worth (excluding art) exceeds the threshold for estate, gift, and generation-skipping taxes (i.e., for a married couple, $10 million plus upward adjustments for inflation), so we can be reasonably sure that a 40% tax will be levied on the fair market value of any art that our collector bequeaths or gives to a child.2 Our collector's options then appear to be:
- Sell the art for $100 and pay tax on the gain. At the federal level, the long-term capital gains tax rate of 28% plus a 3.8% surcharge for the so called "Medicare Tax" should apply, for a cumulative federal tax liability of $28.62 on the $90 of gain.3 This leaves the collector with a net return of $71.38. Assuming this $71.38 is eventually given or bequeathed to the collector's children, an additional 40% gift or estate tax would apply, leaving the collector's children with $42.83.
- Give the art to her children and pay gift tax on the $100. This should trigger a gift tax liability of $40, which the donor would be required to pay. The children would receive the art with a "carryover basis," meaning that the children would be liable for a capital gains tax and Medicare Tax in the cumulative amount of $28.62 upon their sale of the art, as described in the preceding example. This results in a $40 liability for the donor and a transfer of $100 of value to the donor's children, less the eventual capital gains tax liability on this art.4
- Donate the art to a museum and claim a $100 charitable deduction. As we can assume the donor is taxable at the federal level at a 39.6% rate plus a 3.8% Medicare Tax, this deduction can result in a tax savings of as much as $43.40. Assuming this $43.30 of tax savings is eventually given or bequeathed to the collector's children, a 40% gift or estate tax would apply, leaving the collector's children with $26.04.
The examples above provide a rough illustration for the idea that, after tax consequences are taken into account, selling and donating art can yield roughly the same amount of financial value. This is even more likely to be the case if state and local income taxes are figured in, as these additional taxes increase the cost of selling and, conversely, increase the savings to be had from donating one's art to a museum.
For those collectors who would like to partake in the charitable giving described above, but are reluctant to cede control over their collections to a wholly unrelated museum, the idea of establishing their own museum, with curators of their choosing, might be a welcome one. Some of these collectors might even prefer for such a museum to be located on or near their personal residence, or for the museum to display its art within their homes. The challenge for such an arrangement is in determining when a donor's control over a museum renders the museum ineligible for tax-exempt status. The applicable restriction is found in the Treasury Regulations on charities, which state, in relevant part, that "it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests."5
There are only a handful of authorities describing how this restriction is applied to a museum. Private Letter Ruling 8824001 appears to provide the most relevant guidance to persons considering this strategy. The donors described in this ruling were the sole contributors to a charity they had created, and the charity displayed sculptures on the donors' property. Some of the sculptures were viewable from the road, but most were obscured by a privacy hedge or fence. The donors permitted members of the public to tour the grounds upon request. The donors notified various art museums and schools of the opportunity to tour the grounds. The museum had almost 300 visitors per year.
The IRS ruled that this charity did not qualify for tax-exempt status because it ran afoul of the prohibition against operating for private interests. In arriving at this ruling, the IRS noted:
- The absence of a sign to advise passersby of the museum's location;
- That most of the sculptures were clustered near the donors' home and pool, as opposed to more remote and less personal portions of the donors' grounds; and
- The fact that no effort was made to advise the general public of the opportunity for touring the grounds.
From the foregoing, we may infer that a museum located on or near one's property might qualify for tax-exempt status if it is well publicized, physically separated from the donor's personal living spaces, and is identified by signage.
Many donors, however, would be reluctant to create a museum on or near their residence if in doing so they must advertise the museum's location and invite members of the general public to visit. This option is likely to appeal only to donors with estates that are large enough to permit a remote portion to be set aside for a museum, at a distance from their personal residence that is sufficient to permit a measure of privacy. This appears to be the price one has to pay to qualify for a charitable tax deduction for art contributed to one's own museum, where the donor can manage the charity and, to a degree, appear to retain the work by keeping it close to home.
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1 IRS Circular 230 Disclosure: To ensure compliance with Treasury Department regulations, we inform you that any U.S. federal tax advice contained in this document (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the U.S. Internal Revenue Code of 1986, as amended (I.R.C.) or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.
2 I.R.C. §§ 2001 and 2010.
3 The long-term capital gains tax rate from the sale of collectibles, including art, is 28%, whereas the long-term capital gains tax rate from the sale of stock is only 20%. I.R.C. § 1(h).
4 This article does not describe the special rules for determining capital gains tax on property with regards to which a gift tax has been paid.
5 Treas. Reg. section 1.501(c)(3)-1(d)(1)(ii)