Artwork and collections left behind in one’s estate will be subject to probate unless the decedent prepared a trust or other planning tool to hold and manage the art during their lifetime. When art is part of the probate estate, an executor treats the piece(s) like other assets, including the item(s) in an asset inventory and gathering date-of-death values. Where artwork is held in a trust and thus not subject to probate, it is still advisable to obtain an appraisal to determine the date-of-death value of the art for purposes of establishing the beneficiaries’ income tax basis in the property. Regardless whether the art is considered a probate asset, in the case of an estate that is subject to federal or state estate tax, art is a unique asset that poses several potential tax problems.
The Internal Revenue Service may carry out an art valuation audit under certain circumstances. Generally the IRS will review appraisals valued at $50,000 or more; a special appraisal item format is requested by the IRS in such cases. Probate is a notoriously slow process in many states; appraisal and valuation audits could contribute to delays.
If the IRS finds that an error occurred and the art is worth more than what the appraisal stated, the heirs could be burdened with penalties and interest in addition to the corrected tax owed. Penalties are calculated on a sliding scale:
- Penalty of 20 percent of the underpaid tax if an appraisal was submitted valued at 65 percent or less than the IRS’ value
- Penalty of 40 percent of the underpaid tax if an appraisal was submitted valued at 40 percent or less than the IRS’ value
Postmortem sales can cause tax issues for some estates. Executors should keep these events in mind and inform heirs of the potential downsides of selling the artwork soon after inheriting the art. Postmortem art sales could trigger revaluation of date-of-death values, which could have estate tax and penalty implications. Per IRS regulations and as cited from The CPA Journal, “the estate must be valued either on the date of death or the alternate valuation date (AVD) which is six months after the date of death.” An example of potential revaluation issues involves a Pablo Picasso piece left in the estate of Bernice Newberger. When Newberger died in 2009, the piece was appraised by Christie’s at $5 million. Four months following the appraisal, the piece sold at auction for $12.9 million. Four years later the IRS corrected the date-of-death value to $10 million. Even though experts contended the sale price ‘was a fluke,’ the judge found that “no evidence is more probative of the Picasso’s fair market value than its direct sale price.” The $5 million difference between the IRS’ date-of-death value and the original value submitted was subject to a 20 percent penalty and 40 percent in estate tax.
For executors managing art or other collectibles as part of a North Carolina probate administration, here are a few questions they should ask an attorney:
- How many appraisals of the artwork should be completed? It may help to substantiate a date-of-death value if two appraisals are submitted, although some cases might benefit from fewer and/or alternate supporting documentation.
- What other tax issues could be attributed to art in probate? Aside from estate tax, gift tax, and potential penalties, heirs may face income or inheritance taxes depending on their circumstances. North Carolina does not impose an inheritance tax nor a state estate tax as of this writing.
- What’s the first step after receiving notice of an IRS art valuation audit? Follow the instructions provided, notify heirs of the art, and contact a tax attorney.
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