Ep. 66 - The Lifecycle of Art Ownership: Key Legal, Tax, and Practical Considerations for Collectors

Speaker A: Welcome to Future Focused, the podcast where we explore forward thinking, sophisticated estate planning strategies for the modern world and bring you insights and actionable advice to help you navigate the evolving landscape of estate planning. Whether you are a seasoned professional or planning for your own future, this podcast, uh, is your guide to a thriving legacy. Let's focus in.

Speaker B: Welcome to Future Focused. I'm your host, Michael Clear. I am joined today by with a new council, a new addition to our private client service group at Wigan and Dana, uh, Kenley Stark. Kenley brings a new area of practice for us, transactional and tax art practice. And we are very excited with this addition to the firm.

Speaker C: Hi Michael, thanks for having me. This is a really exciting time to talk about art transactions as we finish up a great week of sales in New York at the art fairs and auction houses.

Speaker B: Awesome. Let's just jump right in. Let's say I walk into a gallery or an auction house one day, or I did it this week and I saw a, um, million dollar painting and I loved it and I decided I wanted to buy it. What do I do next? I assume it's a little more complicated than hey, here's a check or some wire instructions and then hanging it on my wall.

Speaker C: Yes, that's exactly right. It's sounds simple, but there are really a series of steps and decisions that follow the decision to buy a work of art. I usually break the life cycle of art ownership into five or six stages when talking to clients about starting an art collection. The economics, the paperwork itself, taking possession, maintenance of the art, how you use the art while you own it, and then eventually how you dispose of it. And then layered on top of all that are tax and cross border issues, things like sales and use tax, vat, gift tax and customs. Other areas related to the type of art that you're buying, whether that's cultural property, modern art, collectibles like instruments or baseball cards that often show up in ways people don't expect.

Speaker B: All right, so from the beginning, I like it, I want to buy it. What am I actually thinking about first?

Speaker C: Yes. So first is the economics and how much do you need to pay for it? So that's generally more than the listed retail price. When you ask the gallery owner, how much can I buy this for?

Speaker B: So then what's baked into price or what are those add ons?

Speaker C: Well, you start with the purchase price, which is, as I said, the gallery price list, or it's the hammer price at auction. Then the dealer's commission, which is often baked into the purchase price in a Private gallery context, you might not have visibility into what that commission is. In an auction context, the buyer's premium is added on top of the hammer price. Then sales tax may be, uh, owed, depending upon where you have the work delivered to or how you take possession or use tax is complementary to sales tax. And then shipping and creating charges might be added on top of all of those. And then finally, if you are working with an art advisor, you might separately owe an advisor fee to your art advisor, depending upon how you're buying it. So that $1 million painting may not really cost 1 million all in.

Speaker B: Let's explore that. So I'm say I'm a little bit earlier in the process. I know I want to collect art, but I don't know exactly what I want to buy.

Speaker C: Yeah. So if you're looking at that 1 million painting, maybe you know you want to buy it, maybe you like it, but you're not quite sure, or you know that you want to start an art collection and you want some guidance. You might decide to hire an art advisor, someone who is well versed in the type of art that you are interested in collecting, someone who understands the market. So that person can help you source works. Think about what type of collection you might want to start dipping your toes into. They might help you evaluate quality, navigate the market, and negotiating the purchase.

Speaker B: I imagine that could be helpful. So in that situation, what should I, or a listener, know about that relationship with the art advisor?

Speaker C: Well, at its core, it's a contractual relationship, so you want to make sure you understand the terms of that relationship. So first you want to know what the advisor is being paid. Is it a flat fee or a commission? The commission would be based on the purchase price of the artwork. The flat fee would be treated more as a retainer. You want to know the scope of their authority. Are they sourcing collections and, uh, artwork acquisitions for you? Are they conducting due diligence on the artworks? Are they helping you develop a cohesive type of a collection? Are they taking you to art fairs? Are they negotiating contracts on your behalf? Or perhaps are they just sourcing potential acquisitions for you? You want clarity about the scope of their authority before they start placing calls on your behalf. You also want to make sure that there are no conflicts, that they are not working with dealers on the other side that might be giving them payment for bringing you in, or that they might not be working with other clients who might want, um, the same artwork

Speaker B: you do who are competing with you.

Speaker C: Exactly. You just want transparency into that relationship.

Speaker B: Absolutely. Okay. So step one is really understand what you're buying, what it actually costs. Do you need help in. Okay, I'm going to create a collection. I have a piece. What is that collection going to look like? Let's just skip to, uh, I'm comfortable with a price. What happens next?

Speaker C: The next step is to review the sale paperwork. That might be an invoice or a more formal agreement. Either way, this is where you confirm what you're actually buying and who bears what risk.

Speaker B: What would we or you be looking for in that sale paperwork?

Speaker C: Yes. This is where we definitely recommend looping in council to review those legal provisions. A few of the things that you are looking for is when title passes, like when do you legally own the work? When does risk of loss pass, meaning when does the responsibility for insuring the work occur? So if it's damaged in transit to you, whose problem is that?

Speaker B: Going right back to contract Barbary, like those cases with risk of loss. Exactly. Okay. Exactly.

Speaker C: Um, we talked about the economics and expenses, but who's paying for shipping? Creating an insurance in terms of the transfer of possession. This relates also to the imposition of sales tax. So who's arranging delivery? When does the responsibility for possession shift than warranties, representations and warranties. You want to make sure that you are purchasing clean title, that there are no undisclosed claims to the artwork. You certainly would like a representation warranty that the artwork is authentic.

Speaker B: You've categorized those things into four. Title and risk, economics and expenses, transfer of possession and representation and warranties. Is that all fairly standard across the board?

Speaker C: It is. Now. Our deals used to happen on a handshake or were written on a cocktail napkin. And thankfully, the higher end of the market has come a long way in the past decade or so. And there's a lot more structure. People are more comfortable having a written agreement that gets negotiated, but sellers will always be more inclined to keep the sale documentation short and sweet. So it's really up to the buyer to request more detail. You want more. More information about the work, its history, its condition. You want more legal representations and warranties, covenants from the seller, and other legal protections for the buyer. As a general rule of thumb, I would advise that for secondary market sales, meaning the work has already been sold before and it's coming up for sale again, or the more valuable or older the artwork, the more a buyer or their advisors should drill down on information about the artwork and those legal provisions.

Speaker B: So this is where we move from, hey, I like this painting to I actually understand the deal that's being created.

Speaker C: Exactly.

Speaker B: Okay, so now I own it and I just, I just take it home.

Speaker C: You can. But you might want to pause for a minute before you take possession. There are a few things that you want to make sure are lined up. Shipping, fine art shipping is specialized. There's professional packing. There's chain of custody condition checking. You want to make sure that you have a fine art insurance policy in place. Many times buyers will add art to their homeowners policy, and that might be fine, but you want to look carefully at the provisions of the policy because art. Fine art insurance policies are very specific about the procedures in place if a work gets damaged. And there are also specific exclusions that are related to fine art. Insurance policies that are geared more towards fine art, like restoration. And a, uh, homeowner's insurance policy likely wouldn't even address that. You want to review the policy. You'll likely insure it at the purchase price, but then you want to make sure that you get periodic appraisals to account for market value changes. And then you also want to think about the care and conservation of the work. Fine art, particularly paintings, drawings, they are very sensitive to light and temperature and humidity, and those can affect the condition over time. So thinking about if you're putting it in storage or you're putting it in your home, making sure that you have a controlled environment for the artwork to live in, is also important to set up at the outset. And then finally, as I mentioned, sales tax can depend upon where you're having it delivered. So if you don't want it to be on your wall immediately or ever, if you're holding it for investment, then you might want to consider having the work delivered directly to a state like Delaware that doesn't impose sales tax. And then if you were ever to bring it back into New York or Connecticut or another state that imposes sales and use tax, you would almost certainly owe, uh, use tax when you bring it back in.

Speaker B: Great things to think about. And you'd imagine on the insurance side, while you're even negotiating that contract, you're thinking about the insurance delivery, where it's going to go, you want that wrapped up. And just the. Where like the. Those are all. Yeah, thanks. Thank you for saving me in our example. And the steal your line that, uh, you gave me because I think it's so great. It's not just ownership of the property. It really is stewardship.

Speaker C: Yes, exactly. It is stewardship. You are taking care of the artwork at that point and you're responsible for preserving its Value and condition.

Speaker B: Okay, so now I own it. What are my options? If you hit it a little, I might store it in Delaware. But is it is my hanging in my living room?

Speaker C: Yep. There are more options than people might realize. One is the most common, which is to take it home and put it on your wall. The second most common is to put it in fine art storage. That could be located anywhere. Depending upon the artwork, a museum or a gallery might reach out to you and request a loan of the artwork, which is really great for enhancing the work's value over time, because exhibition history becomes part of the dossier, essentially, that's created on, uh, an artwork. And you can also use artwork as collateral for a bank loan, which is a nice way to provide liquidity if that becomes of, uh, need.

Speaker B: And I imagine each of those options has different legal implications.

Speaker C: Yes, they all involve different agreements, different considerations, both practical and legal. Importantly, anytime the artwork moves, you may be introducing tax or compliance issues, whether that's state sales or use tax, as I mentioned, or cross border issues like BAT or customs. Again, as you noted, insurance. Insurance is one of the most important aspects of maintaining the artwork.

Speaker B: Interesting. So even moving the artwork, not just selling it, can have tax and insurance consequences associated with it?

Speaker C: Yes. Artwork is a movable, tangible asset. It easily moves locations across state lines. And we saw back in 2020 when people were moving their primary residences, that they were bringing their artwork with them, along with their pets. And so anytime there's a lot of relocation, you have to really think about all the implications of that.

Speaker B: Wow. So eventually I'll want to do something else with the painting. What are my general options?

Speaker C: If you're ready to dispose of the artwork, there are three main paths. The first, which is very common in our field, a private client is transferring the artwork to family during life or death. That can raise a number of considerations. Gift and state tax considerations. You typically need appraisals to establish value. You also need to think about how art is divided among family members. And that can raise issues that are often tied not only to economic value, but also to the sentimental value. You can donate it to a charity, to a museum, a foundation that introduces income tax deduction considerations, related use rules, and a strict documentation of the gift and appraisal requirements. Then you're back to structure, which drives everything.

Speaker B: What are our key choices there?

Speaker C: The first is if you're going to sell privately or or at auction. There are different considerations based on which one you choose. Private course provides more discretion. Auction is public. There are benefits to each of those and cons to each of them. The second is, once you've decided if you're selling privately or publicly, are you going to sell directly or are you going to consign the artwork? So a direct sale is where you, as the seller, sell directly to a buyer and there's no intermediary. That means that you need to find the buyer and negotiate those terms yourself. A consignment is where you appoint an agent to sell it on your behalf and that intermediary markets the work, finds the buyer, negotiates the economics with the buyer, and takes a commission in the middle. So then, depending upon whether you choose private sale versus an auction and direct sale versus consignment, the economics change. So it depends upon the commissions that are paid, it will affect the economics that the seller can negotiate. So in a private sale context, they might negotiate a certain minimum price that they will let the dealer sell it for, which in an auction context might be similar to a guarantee arrangement. There's also an enhanced hammer option in auction sales that allows sellers to receive a portion of the buyer's premium that the auction house receives. And these affect the bottom line for the seller, what they take away at the end of the day.

Speaker B: So not dissimilar to when I'm buying it and when I'm selling it. The structure continues to drive at least some of the considerations and the outcomes.

Speaker C: Yes, absolutely.

Speaker B: Through our conversations today, you've mentioned tax and cross border issues a number of times. How should listeners think about that aspect overall?

Speaker C: So the simplest way to think about it is that art is a movable asset. Across buying, holding, loaning, gifting and selling, you're always watching for first, the structure, what type of transaction is it? You're thinking about the risk allocation, who bears the loss, the claims, the authenticity issues, what else might go wrong in a deal or in ownership. They're looking at the timing. When does money pass hands and when do the tax consequences hit? They're thinking about taxes and cross border. So like sales and use tax, vat, gift and income tax, customs. And the simplest rule of thumb is that movement and transfer of ownership are the moments to slow down and ask questions early. Because if you wait too long until the agreement is signed or the art has been moved, it may be too late to unwind some of those consequences.

Speaker B: Absolutely. Well, we've covered a lot today. I've taken away a number of things, such as when we're working with clients who own art, the key takeaways being how is the transaction being structured, making sure that you see the paperwork early, asking what's happening with the artwork, physically moving the artwork and how you're going to actually use the artwork, never mind a structure again on the backside and you say kind of as once something moves or documents are signed, it's often much harder to change aspects of some of the planning and some of the value add that you can provide during the process. This was a great conversation, Kenley, thanks for joining us today. What I've learned is how complicated this area is, but I think you've given us the process and the cycle that purchasers or collectors will go through. And I think you've also highlighted a number of things that we can have you back in the future to talk about. So I appreciate you joining us.

Speaker C: Thank you so much, Michael. This was fun.

Speaker A: Thank you for listening to Future Focus Sophisticated Estate Planning provided by the Private Client Services Department at Wigan and Dana. Our aim is to preserve the wealth that a family has worked so hard to create and we pride ourselves in offering value driven solutions and results. Subscribe to the show on your favorite podcast platform, share episodes with your clients and follow our highly talented, creative and experienced lawyers on LinkedIn for even more great insight. We'll see you next time on Future Focused Sophisticated Estate Planning.