Word on the street is that collectibles appraisers have had a busy year. With the lifetime gift tax exemption scheduled to drop from $5 million to $1 million on Jan. 1, 2013, collectors are scuffling to pass on as much tax-free wealth as possible to their children and heirs.
Collectors who gift this year will save themselves some money in gift taxes, as well, because the gift tax rate jumps from 35 percent to 55 percent on the same date. The individual who gives the gift pays the taxes on any amounts over their lifetime gifting exemption at the rate current at the time of the gift. So, even if you’re approaching your lifetime gifting limit, if you are sitting on a valuable collection that will someday pass to an heir, now is the time to consider how you will transfer the property.
As the filing deadline closes in, both collectors and appraisers will be pressured to get appraisals and paperwork done on time. Mistakes will be made. In a rush, collectors will turn to “quick and dirty” appraisal methods that will be rejected by the IRS and they will end up paying additional money in taxes, fines, and penalties. The appraisers who performed the valuations for the rejected tax returns may be heavily fined and barred for life from submitting appraisals to the IRS. When it comes to gifting collections, both collectors and appraisers need to move cautiously.
Read more: IRS Gift Tax Definition & Related Topics
Collectors who don’t plan to gift any of their collection this year may also be interested in this discussion, because at some point in the future, their collection will pass to someone else, whether by gift, bequest, or sale. It’s been estimated that in the next 40 years, billions of dollars of wealth, in the form of collectibles, will pass to succeeding generations.
The IRS looks at the valuations of comic books, musical instruments, coins, art, and other collectibles closely. My intent in this column is to raise a few “red flags” for collectors who may be moving forward with gifting all or part of a collection this year. My usual disclaimer applies: I am not an accountant or attorney and cannot legally give tax advice. I can’t even spell IRS. But I have performed gift appraisals and have never had one of my appraisals questioned by Uncle Sam. My role is like that of a driving instructor: I can tell you where the hazards in the road are, but I’m not the traffic cop. You have to do your own driving. If you plan on gifting, seek professional tax advice.
The 2013 deadline aside, there are other issues to be considered when gifting a collection. For example, what amount will be taxed? Gifted collections keep the tax basis/value they had when they were gifted, but inherited collections assumed fair market value at the time they were inherited. What will the tax rate be? Will the tax be paid on ordinary income (if the collection was part of a business operation) or as investment income? There may not be much difference between the two rates; investment collections are taxed at 28 percent, not the 15 percent that most people assume. Add in the possibility of tax claw-back, future income taxes, and IRA complications, and you can see why you need to consult with a tax expert. Makes my head spin just to read this paragraph. Here’s how this may translate in the real world:
My client, Doug, had been downsized and needed to raise some cash while he looked for a job. Twenty-five years ago, Doug had removed a guitar collection from his wealthy father’s estate before the inventory was taken, so the guitars were not included in the estate. Doug reasoned that his father had always intended for him to have the guitars but had never gotten around to saying so in his will. My job was to appraise the guitars and recommend selling options for the instruments. After some research, I told Doug that the guitars had a combined value just over six figures. He was also surprised to learn that he might have both a criminal problem and a tax problem today because of his action 25 years ago.
Establishing the value of the guitars 25 years ago with any certainty would be difficult today, but it is certain that they had appreciated from their original cost (the original tax basis). Had they been included in the estate inventory, their tax basis when Doug acquired them would have been established (fair market value), but no appraiser ever saw the guitars. Since Doug’s father had a large estate, the guitars would undoubtedly have been subject to estate tax. The guitars were not included in the estate inventory, so the tax on them was never paid.
If Doug sells the guitars, he will make a handsome profit, and he will owe capital gains taxes (at the 28 percent rate for collectibles). If the IRS decides to audit the return, they will certainly want Doug to provide purchase receipts to establish the tax basis for the guitars. If it is discovered that Doug removed the guitars from his father’s estate, Doug will owe the unpaid estate taxes plus penalties and interest and may face criminal fraud charges (there is no statute of limitations on fraud).
The lesson? If you intend for your heirs to inherit your collection, you will save everyone a lot of money and trouble by gifting the collection while you are still alive. The other lesson? Don’t think you can con the IRS. They will find you, and then fine you.
Perhaps the most important consideration in gifting is the value placed on your collection. Unless you have purchase receipts to validate the original cost of each item, you will need to have your collection appraised. “Appraisal” is one of those words which are so casually tossed around that it is almost meaningless. We regularly see “Appraisal Fairs” offered by dealers and appraisers alike. Make no mistake: What you are getting at such events is not an appraisal; it is an unsubstantiated personal opinion. Of course, we all know that home appraisals have strict rules and a specific format. Most folks are unaware that the IRS requires personal property appraisals to follow the same rules and be submitted in a similar format. If you’ve had your local auctioneer or antique/collectibles dealer make a list of your items and assign them a value, this list is not an appraisal that the IRS will accept. Neither will the IRS accept an online appraisal given from a photograph.
If you are going to have your collection appraised, make sure that your appraiser has successfully submitted appraisals to the IRS for the type of collection that you will be gifting. If you can’t find such a person, here’s what the IRS expects:
Unquestioned expertise proven through either education or experience (certification or training from an appraisal organization or verifiable industry training and/or experience).
Follow the format prescribed by the Uniform Standards of Professional Appraisal Practice (USPAP) .
Whether you plan to gift your collection this year or in 10 years, most folks find that gifting is a better solution for their family than bequeathing a collection through a will. Either way, proceed with caution.