By Randy A. Fox, CFP, Founding Principle, InKnowVision, LLC
High net worth individuals who have built up large collections might find that while their advisors are willing to talk them about stocks, bonds, hedge funds, real estate, and other traditional assets, very few even think to discuss fine art and other collections. While a few may consider the "collection" category as a non-correlated alternative investment strategy and treat it that way, those who collect usually collect for other reasons. In fact, collectors don't often think of collectibles in terms of financial worth but instead think in terms of emotional satisfaction and an important part of who they are as people. The psychic reward far outweighs the dollar cost.
Most collectors don't discuss their collections with their advisors and their advisors overlook this subject almost entirely. It is an asset class however, that sorely needs attention. It's estimated that 30% of families with net worth in excess of $10 million collect something. Normal collections may represent around 10% of total wealth. And most collectors collect more than one category. Couple this with the fact that collectors tend to be very passionate about whatever it is they decide to collect and you may have the single most important category of assets in a family portfolio.
If the heart and soul of a family is tied to a collection, then passing it to succeeding generations is supremely important. Yet, entire collections are often overlooked in the planning for those very families because the subject never surfaces. Collectors don't think of their art or antiques like they think of their stocks and bonds and businesses. These things are personal. Collections get swept into "personal property" or "household items" with no thought as to the consequences of dismissing an entire asset class.
Art, Wine, Classic Cars? Why Planning For Collectibles Is Critical
Without sufficient planning, a lifetime of collecting and legacy building can disappear overnight. The death of the older generation often causes a cascading series of problems; children fight over who gets what; lack of liquidity causes forced liquidations to pay unforeseen estate taxes; auctioneers fees reduce proceeds to a fraction of value. And while many otherwise intelligent collectors rigorously plan the accumulation of their prizes, most never think of the disposition, mistakenly thinking that their children will simply take the art off the walls, empty the wine cellar and move the classic cars to a new garage. Of course, this is a license for disaster. And tax fraud.
The simple answer for collectors is that planning for their collection is as important as planning for their other wealth and, in fact, the two must be totally integrated in order for them to have a successful transition of their legacy to succeeding generations. Experience shows that these conversations are not taking place, at least not often enough. Most advisors don't feel comfortable talking about the subject of collections or, worse yet, don't even consider them. There are, however, a select few "art succession" advisors who are able to open a conversation about the importance of the collection, its history and meaning, its scope and specialness. Serious collectors should avidly seek out these advisors for this portion of their family's succession plan. Collections can be catalogued, evaluated, sorted, ranked and authenticated. Discussions about which items are important, which could be sold or donated, which should go on exhibit can take place.
At this point, the family advisory team can begin the process of consolidating planning ideas into a complete plan that will fulfill the collector's dream for the collection within the entirety of his wealth. When this type of planning is undertaken, the results are incredibly powerful.
Case Study: Getting The Most Financial & Emotional Benefits
The following is a case study taken from an actual client engagement that demonstrates the potential benefits of discussing and implementing strategies for collectibles within the context of a family's finances.
John and Janet are 67 and 65 years old with two grown children and a number of grandchildren. They have been avid collectors and have what many consider the preeminent collection of its type. The collection has been valued at $12 million while their entire net worth is a little over $22 million. Their other assets include hedge funds, some investment real estate and marketable securities.
The collection has been coveted by the local museum for some time but John and Janet have held out until now. They would like to keep the collection together or at least get their children more involved. After inheriting some family wealth, John has been a college professor for his entire career and has reached the age where he finally wants to retire.
Unfortunately for John and Janet, their real world investments have been hit hard by the market downturn and John is only a co-owner of some of the real estate with his brothers and sisters. He can't act alone and has left the management to them. Though they live a modest lifestyle, there is still not enough cash flow for them to retire as comfortably as they would like.
Faced with these challenges, John and Janet's advisors suggested liquidating all or part of the collection or selling their modest house or reducing their lifestyle needs. While each of these ideas may actually work, none are truly satisfactory. Additionally, when John and Janet die, much of the collection will have to be sold or donated to pay or avoid estate taxes.
Instead of compromising their goals, John and Janet engage an art succession advisor who suggests the following:
- The collection is catalogued, organized, and fully authenticated. This process alone has often raised the value of a collection by as much as 10%. Then, John and Janet separate the pieces into three "classes" so that they can more easily decide on what to keep, sell, donate or transfer. Many collections fall into the roughly the same three categories.
- Next, they enter the financial/estate planning portion of the process with enough conviction and clarity about the outcome they want. The first financial step is to approach the museum and negotiate a bargain sale for a portion of the collection. In this case, they agree to sell $6 million of the collection for $4 million. This accomplishes a few things. They get some much needed cash, though they owe capital gains tax at 28% for collectibles, not the 15% that common stockholders receive when they sell their holdings. However, they also receive a $2 million charitable income tax deduction for the "bargain" price they gave the charity.
- Next, they take $2 million of their reinvested cash and $2 million of their collection and contribute it to an LLC. After an appraisal of the LLC interests and proper seed gifts, they then sell the non-voting units to newly created Grantor Deemed Owner Trusts in exchange for a note. The GDOT will utilize the reinvested cash to pay the note as well as to purchase $5 million of survivorship insurance on John and Janet.
- They then create a Flip-Charitable Remainder Trust (Flip-CRT) for the remaining $4 million of the collection. They receive an additional charitable income tax deduction and can use it for the current year and five succeeding years. The Flip-CRT allows them to receive income after the collection is sold. They once again approach the museum and the museum agrees to purchase the balance of the collection. In exchange for this, John and Janet make the museum the irrevocable beneficiary of the remainder interest in the Flip-CRT. Essentially, the museum will be reimbursed for their purchase when John and Janet pass away.
- The prior strategies create enough additional cash flow to fund an additional $10 million of survivorship insurance in an Irrevocable Life Insurance Trust.
Collection Lives On
While John and Janet weren't able to keep their collection completely together, they were able to keep it as one and build it over time. The museum was gracious enough to name the collection in their honor and the children's trusts can lend or gift their pieces over time. John and Janet succeeded in securing their income for retirement, have completely eliminated any estate tax which would have been accompanied by a forced liquidation of their collection and their children have some of the art and enough liquidity to begin their own collecting.
While this type of planning isn't done often, it certainly is a subject that should be discussed with every serious collector. The outcome for the family can be vastly improved and the collection can be preserved as the family desires.
