Establishing a Value is Important!

Establishing a Value is Important!

Article posted in Compliance on 10 May 2004| comments
audience: National Publication | last updated: 18 May 2011


Given all the attention by the Courts and Congress regarding the valuation of charitable contributions of art, instruments, and autos, PGDC Editorial Board member Vaughn W. Henry discusses the estate of artist Georgia O'Keeffe and its application of "blockage discount" to the valuation of the estate's collection.

By Vaughn W. Henry

In light of recent news stories and articles about charitable gifts of musical instruments, artwork, and autos, proper valuation has been the subject of much political posturing and hand wringing by a number of charities. "Hard to value assets" are aptly named because they are usually subject to varying appraisals. It should be no surprise the IRS prefers its appraisal, especially if it will generate more revenue. Of particular interest in the discussion of value is how tax judges view the use of qualified appraisers and their contributions to the establishment of fair market value. This process has important implications in the solicitation and management of charitable gifts, so it is illustrative to review the O'Keeffe v. Commissioner valuation case from 1992.

Georgia O'Keeffe, a noted Southwestern artist, died at the age of 98 on March 6, 1986 still possessing over 400 of her works of art. O'Keeffe's will, executed in 1979, with a 1983 codicil and a settlement agreement (resolving litigation over the estate in 1987), provided for the distribution of 42 of O'Keeffe's works to eight museums. After the settlement agreement, the Museum of New Mexico and the University of New Mexico received five more artworks from the estate. The works distributed to all the museums had individual values ranging from $40,000 to $1,800,000 and a total value of $22,575,000.

The estate's appraisers, who were well qualified and had already testified in previous tax court cases 1, established the fair market value of her unsold artwork at $18 million, based on consumer demand and blockage discounts for a large amount of art by a single artist that would suddenly flood the market. Additionally, the estate representatives held that not all of the remaining art works were in good condition or comparable to those works previously sold at public auction. Nevertheless, the IRS valued O'Keeffe's artwork at nearly $72.8 million, based on historical sales of her single pieces. In a Solomon-like decision, the Tax Court split the difference and valued the collection at $36.4 million, the net effect of which was the tax on that value alone was higher than the estate's original value of all the art works in question.

However, there is more to the story; and it hinges on the appraisers' interpretation of value for estate and charitable purposes. In fact, both the IRS and estate appraisers were able to agree on the fair market value of $72,759,000 for the art works in question. The real sticking point was the timing issue or "blockage discount," that would have reduced the values when a large number of pieces hit the market at the same time. The estate's appraisers indicated that a 75% discount was appropriate as a blockage discount, for pieces it planned to market via a single bulk sale to a dealer. The IRS' position was that higher prices would be achieved with one at a time sales in an orderly process over a few years, contending the pieces were offered in isolation on their individual merits. Neither the IRS nor the Court was persuaded that the artwork would not appreciate over time, or that the costs of sales and commissions would significantly diminish value. However, the Court rejected the IRS position that the length of time needed to reasonably market the artwork would exceed the time allowed to close the estate and deduct the expenses under 2053. Of particular interest was the Court's determination that it would not be bound by either appraiser's work, especially when it found the biased testimony was not credible or did not follow accepted law. The Court held that it may reject expert analysis or proposed transactions that are unlikely, or without justification in the marketplace of willing buyers and willing sellers, or are contrary to the interests of a hypothetical buyer. By repudiating the positions of both parties, the Court allowed a 75% blockage discount to the one-half portion of the collection likely to require an extended period of time to sell, but only allowed for a 25% discount for items expected to sell quickly, and thus valued the O'Keeffe collection at $36,400,000.

Art, by its nature, is valued subjectively, and normally identifies traditional factors in the art market like rarity, quality, size, subject matter, medium, and condition. Besides expert opinion, cost or selling price, comparable sales, and replacement cost may enter into the value equation. Additional requirements for required appraisals are outlined for the assets over $5,000 are defined in IRS Publication 526 and IRS Publication 561. To substantiate the deduction, the taxpayer completes an IRS form 8283, signed by competent professionals, and for artwork valued at $20,000 or more, a signed appraisal must be included. To keep the donee charity in the compliance loop, an IRS form 8282 is required if the donated asset is sold within two years. In order for any taxpayer to claim a charitable income tax deduction, a receipt from the donee for any donation over $250 is required by IRC Section 170(f)(8).

It is clear that there are numerous traps in setting value for the deduction of hard to value assets; both the donors and their advisors need to become more familiar with the requirements to substantiate and report charitable gifts.

  1. The appraiser, Mr. Thaw, had testified as a witness on the blockage discount appropriate in the Tax Court case of Estate of Smith v. Commissioner, 57 T.C. 650 (1972), affd. 510 F.2d 479 (2d Cir. 1975). The Smith case was the first litigated case to apply a blockage discount to works of art.back

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