Art may be in the eye of the beholder, but art valuation for tax purposes is in the eye of the IRS.
Improper deductions based on inflated art valuations are now in the agency's crosshairs, part of an ongoing expansion of audit and investigations into charitable deductions for art donations.
But taxpayers need not be deterred from making charitable donations of art. Instead, they should prepare to defend large art donation deductions.
Learn how the charity will use the art. Taxpayers should be aware that permissible deduction amounts for art donations depend on whether the charity uses the donated artwork to further its tax-exempt purpose.
If so, they generally may deduct the fair market value of the artwork as of the donation date with some exceptions, such as art donated by the artist and gifts of art owned by the donor for less than one year.
If the charity doesn't use the artwork to further its tax exemption, a taxpayer may deduct only the lesser of the artwork's cost basis or fair market value.
If the charity sells the artwork within three years of the donation, the donor recaptures as income the artwork's appreciated value as of the donation date, if any, unless the charity certifies that its use of the artwork was substantial and related to its exempt purpose.
A taxpayer may confidently deduct the donation date fair market value for art donated to an art museum, art gallery, or other nonprofit art institution, as the use requirement is presumptively satisfied.
If the charity isn't an art institution, the taxpayer should insist on entering into a grant agreement with the charity obligating it to use the donated artwork for a purpose that satisfies the exempt use requirement—for instance, by agreeing to display it in the charity's facility.
Hire a qualified appraiser. Taxpayers claiming art donation deductions should retain an appraiser with excellent credentials, expertise in the specific artwork at issue and knowledge of the market.
Not all appraisers are created equal. A qualified appraiser must be free of conflicts of interest.
The donor, the donee, the party that transferred the art to the donor or its agent, or any of their employees or related persons under Section 267(b) of the federal tax code can't serve as a qualified appraiser.
Auction houses are a reliable resource for identifying qualified appraisers. Professional organizations—such as the American Society of Appraisers, Appraisers Association of America, and International Society of Appraisers—are another resource.
Keep detailed records. Taxpayers should comply with applicable recordkeeping and substantiation requirements, which are determined by the deduction amount.
For art donation deductions of more than $5,000, a taxpayer must obtain a qualified appraisal of the artwork and complete Form 8283—Noncash Charitable Contribution—signed by both a qualified appraiser and the charity.
For art donation deductions of $20,000 or more, a taxpayer must submit to the IRS the qualified appraisal and an 8-by-10-inch high-resolution photo of the donated artwork. Art donation deductions under $5,000 don't require a qualified appraisal but still must be substantiated, with differing requirements based on the deduction amount.
Failure to include in the qualified appraisal any of the following information may subject the art donation deduction to challenge by the IRS:
- Complete description of the artwork, including the artist's name, artwork's title or subject matter, type of art, creation date, dimensions, any distinguishing features, and proof of authenticity, if available
- Artwork's physical condition
- Donation date and appraisal date(s)
- Any agreement with the donee related to use, sale, or disposition of the artwork
- Qualified appraiser's name, address, identifying number and qualifications, and employer's identifying information
- Statement that the appraisal was prepared for income tax purposes
- Artwork's appraised fair market value on the donation date, specific basis for the valuation and method used to determine the fair market value, and qualified appraiser's signature
Consider a statement of value. For works of art valued at $50,000 or more, taxpayers should consider a powerful protective measure that isn't often used: a statement of value from the IRS.
At the taxpayer's request, an independent IRS art advisory panel will evaluate a qualified appraisal before the taxpayer submits its income, estate, or gift tax return. If the IRS doesn't issue the statement of value before the return is due, the taxpayer must attach the request to its return and later amend the return on receipt of the statement.
A taxpayer may rely on the statement of value to substantiate the art donation deduction amount and avoid audits and potential valuation understatement penalties, which can be 40% if the claimed valuation exceeds the correct value by at least 200%. Taxpayers who disagree with the statement may claim a larger deduction amount, but the statement is difficult to overcome.
While an IRS auditor wouldn't increase the valuation of an art donation deduction during an audit, that's not the case with the art advisory panel's evaluation of a requested appraisal.
When evaluating an appraisal, the art advisory panel is unaware of the taxpayer's economic interest in the valuation of the artwork (as it would advantage the taxpayer to increase the valuation for art donation deductions, but not for estate and gift tax purposes).
For fiscal 2022, the panel agreed with 35% of appraisals submitted, increased the value of 31% and decreased 34% of appraisal values submitted. Taxpayers should be aware that IRS art advisory panel evaluations are a mixed bag.
Reproduced with permission. Published May 7, 2024. Copyright 2024 Bloomberg Industry Group 800-372-1033.
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