Deferred giving of art: the joy of keeping your treasure just a little bit longer.

Most practitioners agree that standard deferred charitable giving vehicles involving trusts do not work when the subject of the gift is tangible personal property. The problem is that there can be no assurance in a standard charitable trust arrangement that the museum will ever actually receive the precise piece of art being placed in the trust. All is not lost, however; there may be a way to achieve similar tax results by making a present gift of a percentage interest in one's prized possession.

A percentage interest in a great work, even as small as 10%, can be valuable to a museum for several reasons. First, a percentage interest can give the institution the right to show a work for part of the time, to include it in special exhibitions, or to make it available in some other way for the community as a whole to enjoy and treasure. Alternatively, if the work is ever sold, the museum can share in the proceeds to fund acquisitions of other works. Finally, and probably most importantly, the museum can hope, by acquiring an entry-level percentage interest in the work, to form a relationship with the community of its other present and future co-owners, which might lead to its full and permanent addition to the collection.

Museum policies vary drastically about accepting percentage interests in artworks. Some welcome them avidly; others look at the number of person-hours required to accept and care for an object, and deploy their people resources in other directions. Most museums that accept percentage-interest gifts consider only the most important works consistent with their collection policies.

Here are a few tax considerations associated with gifts of artwork in general, and percentage interests in pieces of art in particular. * The basics: When a collector gives a work of art to a museum, the donor is generally entitled to deduct the fair market value of that gift in computing his taxable income. Deductions for contributions of personal property are limited to 30% of the adjusted gross income on the tax return, with the excess being carried forward and used in the five succeeding years. For the donor to get the market value deduction, the museum needs to agree to report any disposition of the work occurring within two years of the gift. In general, tax-advantaged gifting strategies are available only to collectors -- an artist faces the issue of art as inventory, with the deduction limited to cost.

How to do it: The actual gifting of a percentage interest in a work of art is usually a fairly straightforward two-step process. First, the donor and his attorney prepare a deed or similar document, and specify what they want to donate to the museum -- the percentage, a description of the work, and the terms and conditions under which the donor is offering it to the museum. The museum then executes an acceptance to close the transaction. Museums that want these gifts frequently have standard form gift documents on hand, which can be used as a starting point in donor-institution negotiations. * Tax compliance: Regs. Sec. 1.170A-13(c)(2) and (3) apply to whole or fractional-interest gifts of art to museums. The gift is reported on Form 8283, Noncash Charitable Contributions. Appraisals are needed for gifts of objects exceeding $5,000 in value. Appraisers have to be independent of the donor and the museum, and compensated by the donor, not the institution. An appraiser acknowledges that the purpose of the appraisal is to support a tax deduction, and agrees in advance to specific sanctions in the event the appraisal is deemed a material misstatement. Appraisal fees for charitable donations are not deductible as additional charitable contributions, but as miscellaneous itemized deductions. Perhaps the most important consideration about the appraiser is his qualifications (i.e., in-depth knowledge about the objet d'art being appraised). The appraiser must also provide insight and documentation to sufficiently convince the taxing authorities that his opinion about the work's value is correct.

The donor faces separate penalties of his own for a serious overvaluation of a charitable contribution. In engaging an appraiser for an important and valuable work, a donor should understand clearly how object-specific the appraiser's expertise is likely to be, and how much work the appraiser is agreeing to do to focus that expertise. The objective is usually to get an appraisal of the donated object that is as high as possible, but still independent and reasonable, and to avoid its categorization as an "advocacy" appraisal.

A key element of the value of an important work of art can be the channel through which it is sold (e.g., at auction, through a gallery, in a private sale or in a specific country or range of countries). The major cases in this area are Jennings, TC Memo 1988-521, and O'Keeffe, TC Memo 1992-210, which discuss in depth just how important marketing can be to the value of art. The appraiser chosen should have convincing knowledge of the specific markets in which the specific artist's work is most commonly sold. When a work's identification is only time-period and condition- and location-specific, the appraiser's access to relevant databases can be a key factor in an acceptable appraisal. Appraisals based solely on auction data may tend to be more conservative than those based on dealer-and gallery-sale numbers. This is a result of the "perfect competition" auction environment, as opposed to an environment that can be more influenced by personal marketing activities.

Another key factor in the acceptability of an appraisal can be the amount of contact the appraiser has had with the work of art. An appraisal based on only a picture of the work can be unconvincing about its condition, which can be a key determinant of value. On the other hand, an association of art dealers in New York maintains an appraisal service that usually submits only pictures of works under appraisal to the appraisal process, but the process involves thc interaction of multiple appraisers for a consensus appraisal. The resulting work product has been found highly convincing in a number of cases.

The IRS can have an impact on an appraisal deduction in several ways. For a fee of $2,500, it will review an appraisal prior to the donor's tax return filing, and give its opinion of the value of a work of art valued at more than $50,000. The procedure for obtaining such an appraisal can be found in Rev. Proc. 96-15. For the donor who can feel comfortable using this kind of valuation, the procedure can yield peace of mind.

Alternatively, a large deduction for an art donation can be examined and challenged by the Service after the donor's tax return has been filed. For challenged deductions over $20,000, the IRS maintains an Art Advisory Panel in Washington, D.C., which consults with experts in all fields of art, reviews the appraisals submitted, and ultimately decides the Service's position on the value of a given work. Since such a challenge and determination might ultimately lead to an increase in tax, penalties, litigation or a three, the importance of the quality of the appraisal cannot be overemphasized. This may be particularly true in light of the fact that at a panel meeting, the only nonmembers present may be IRS employees, not experts or representatives of the taxpayer.

As might be expected, the IRS Art Advisory Panel's 1996 report says that it found what it considered serious undervaluation in estate and noncharitable gift settings. It recommended upward valuation in 54% of the cases it reviewed, and adjusted total values by an average of over 45%. The corresponding overvaluation problem seemed less pronounced in charitable contribution settings. There, the panel recommended downward valuation changes in only around 30% of the cases, and adjusted total values by an average of less than 200%.

The policies of both the Service and many reputable appraisers require that the work of art actually be donated to the museum, before beginning the appraisal engagement. Potential donors should be more or less alert to this consideration, depending on just how tax-driven the donation is.

A concern of tax practitioners is whether a percentage interest in a work of art should be valued by multiplying that percentage by the total value of the work, or whether a minority interest should receive a discount. Percentage-interest gifts seem to be a relatively recent phenomenon, and detailed guidance is lacking. There is some question as to what rights the museum has when it simply holds a percentage interest in a work of art. Can it force a sale to obtain value? Can it take possession for fixed future periods? Does it have any, special obligations or face any restrictive conditions about its handling of the object? Most answers will lie in the terms of the deed -- which should be drawn very carefully and to the donor's comfort.

In Winokur, 90 TC 733 (1988), a museum chose not to take possession of artwork to which it had a clear right of part-time possession, and an undiscounted percentage interest deduction was still sustained by the court. In Letter Ruling 9303007, the IRS held that, even in the face of major fiduciary-type restrictions to a museum s rights to artwork, an undiscounted percentage value of the work was deductible.

The fractional-interest discount question is and will probably remain an open question, and one very dependent on the facts surrounding each specific work of art and its percentage-interest donation. One factor often overlooked is who determines whether the discount should be applied. Taxpayers should avoid engaging appraisers who force the taxpayer or his tax adviser to determine this point; these individuals usually do not have the expertise of art appraisers, or access to the data sufficient to exercise such expertise.

It has been said that half a loaf is better than none. This same principle is true for partial interests in the right artworks. Under the right circumstances, such a gift can be highly meaningful to a museum and, when properly executed, highly tax-beneficial to a donor. From Hal McKinney, Jr., CPA, Hood & Strong LLP, San Francisco, Cal.