Dealing With Valuable Personal Property in Estate Is, Well, an Art

Collectors beware.

If you collect art--or baseball cards, jewelry or any other valuable personal property--you may have a looming estate tax problem, says Leah M. Bishop, a partner with Los Angeles law firm O’Melveny & Myers.

The tax implications of passing on art and other valuable personal property--regardless of whether you’re living or dead--are dicey. But the arcane rules that can trip up the unwary can be used to your advantage if you know what they are and how to use them.

For instance, you can give appreciated stock to a charity and get a tax deduction for the current market value of the stock, no matter what the charity does with it. But if you give appreciated art to a charity, you’d better be sure that you give it to a “related use” charity such as a museum, or that the charity plans to keep the artwork for a while. Otherwise, your tax deduction would be the lesser of what you paid for it or the current market value, Bishop warns.

Consider, for example, what would happen if you bought a painting for $10 at a garage sale and then discovered that it was the work of a famous artist and worth $10,000.

If you give it to a museum, you’d get a $10,000 tax deduction. But if you give it to your alma mater, which turned right around and sold it for $10,000, your deduction would be limited to $10--just what you paid for it. On the other hand, if your alma mater agrees to hang it on one of its walls for at least two years before selling it, you would get the full $10,000 deduction.

The same holds true for baseball card collections and family heirlooms. If you expect to get the full-market-value deduction, you need to make sure that the recipient charity is using, rather than selling, your collection.

What if you don’t want to give your art or heirlooms to charity but want to leave it to your best friend--another avid collector--when you die? Consider the future tax implications. If estate taxes would be due on this item (for 1999, estates above $650,000 are subject to tax), they’d normally charged to the person who receives the gift. If that person is unable to pay the tax with his or her own resources, the recipient may have to sell the artwork just to pay the tax, Bishop says. If you want the tax paid on that item before remaining assets are distributed to other heirs, you must say so in your will, she adds.

If you can manage to part with the art before you die, you may be able to avoid the tax completely. That’s because you can give gifts worth up to $10,000 per beneficiary per year without suffering any gift or estate tax consequences. (Gifts of more than $10,000 must be reported to the IRS and reduce the amount you can eventually leave to your heirs tax-free.)

“But giving it away means giving it away. It’s not, ‘When I die, this one’s yours,’ ” Bishop says. “It’s got to come off your wall and be put up on theirs.”

Who will know the difference? The IRS. Unlike the situation with ordinary tax returns, which are rarely audited, the odds of your estate tax return’s being audited are relatively high--particularly if its a large estate, says Mark Luscombe, principal tax analyst with CCH Inc., a Riverwoods, Ill.-based tax research and publishing firm. About 13% of estate tax returns are audited. But on estates worth $5 million or more, the figure climbs to 47%, he says.

The first thing auditors look at is the decedent’s homeowner insurance policy, Bishop says. If you have valuable personal property-- regardless of whether it’s a painting, sculpture or jewelry--it’s likely to be listed on a rider to your policy. That makes it pretty easy to nab tax cheats.

The fact that heirs often squabble over the jewelry and other heirlooms, filing reams of paperwork in probate court about how “Susie grabbed the silver collection” or “Paul nabbed the Picasso,” also can make an auditor’s job easy, experts add.

If you need some current tax deductions but can’t stand the thought of parting completely with a valuable work of art, there’s a controversial technique called “fractionalizing” that can work for people with particularly famous or sought-after collections, Bishop says.

For instance, you have a Van Gogh worth $250,000 and a local museum that would love to display it during its annual Van Gogh exhibition. You can donate a one-twelfth interest in the painting, which gives the museum the right to exhibit it for one month a year. You keep it for the remaining 11 months.

You get a current-year income tax deduction equal to one-twelfth of the work’s market value, or $20,833. And when you die, one-twelfth of the value of the painting is taken out of your estate for estate tax purposes, reducing the tax burden on your heirs.

If you like, you can continue to give a fractional interest in the painting to the museum, getting additional tax deductions (and giving up access to the painting for a time each year), or you can leave the remaining interest in the painting to your heirs.

But remember, the gift to the museum is not temporary. Neither you nor your heirs can simply change your mind and take it back. If the IRS determines the gift was bogus, you--or your estate--can be on the hook for back taxes and penalties.

Moreover, be careful to set up the gift appropriately--and keep good records--for the simple reason that the IRS does not like these clever deals, Bishop says.

In situations in which you must fight to maintain your deductions, you should know that the burden of proof lies with you, the taxpayer.

Times staff writer Kathy M. Kristof can be reached by e-mail at kathy.kristof@latimes.com.