WSJ: Congress May Revise Restrictions on Fractional Gifts of Art

Wall Street Journal:  A Portrait of Art as a Tax Deduction, by Mike Spector:

Jon and Mary Shirley used to give artwork by the likes of Jackson Pollock, Mark Rothko and Alberto Giacometti to the Seattle Art Museum. No longer. A federal crackdown on deductions for so-called fractional gifts of art has made donating too onerous for them.

Before, the Shirleys could donate small stakes in their artwork to the museum over time and reap increasingly larger deductions as their collectibles appreciated. But Congress changed the rules nearly two years ago, capping those deductions. ...

Museum directors say these restrictions -- which limit tax breaks for givers -- have crimped donations of valuable collections. ...  Now lawmakers, under pressure from museums, are mulling easing some of the restrictions. Sen. Charles Schumer (D., N.Y.) and Sen. Charles Grassley (R., Iowa) are working on a plan to once again allow partial-gift donors to take ever-larger deductions as their artwork appreciates ....

Donating art also shields them from a big tax bill. Though many collectors could make a bundle selling into a hot market, they'd be hit with a sharp federal capital-gains tax -- up to 28% -- on art and collectibles (as opposed to the lower 15% rate on stocks and bonds). That gives them an additional incentive to donate and take a deduction instead. These deductions can prove sizable. While the stock market has stumbled and banks have collapsed, art's value has kept on rising. ...

Besides tax planning, the fractional-gift strategy provided collectors an additional advantage: It allowed them to park their art in a museum for part of the year, then bring it home to enjoy for the remaining months, depending on the deal they negotiated. They could also claim increasingly larger deductions as the artwork appreciated over time, before the museum eventually took sole possession.

Here's how it worked: The donor would take a deduction based on the first contributed stake -- say, $4,000 for donating a third of a $12,000 painting. If the collector donated another one-third stake later, and the $12,000 painting had appreciated to $30,000, the next deduction would be $10,000. The donor could continue to take advantage of this until he gave away the entire interest in the artwork, and he could take as many years as he wished to do so.

Measures passed as part of a 2006 pension-reform law limited that sweet deal. Sen. Grassley has said that he led the charge for stricter rules after reading an article on the topic in The Wall Street Journal, alarmed that donors were taking bigger and bigger deductions while still keeping the donated artwork on their walls much of the time.

Today, it doesn't matter if that $12,000 canvas leaps in market value to $30,000; art contributors can't take ever-larger deductions if the donated artwork continues to rise in value. As far as the Internal Revenue Service is concerned, for deduction purposes, the value remains frozen at $12,000, the value at the time of the initial gift. Worse for donors, if the artwork happens to depreciate, later calculations are based on that lesser value.

Additionally, art givers now have only 10 years -- or until the donor dies, whichever comes first -- to hand the work over to a museum for good. Otherwise, the IRS recoups a portion of the deduction, plus interest and penalties.

The Schumer-Grassley plan would ease some of these restrictions, but would add others, according to the people briefed on the negotiations. Collectors would once again be allowed to take bigger deductions over time as their art appreciated. But higher art values, for tax purposes, would be restrained by any deductions taken previously, under one option being discussed. For example, say a donor gave 10% of a painting valued at $100,000. For that initial gift, the donor could deduct $10,000.

But when calculating the next deduction for a partial gift in a later year, the painting would be valued at only 90% of its fair-market value. If in the later year the market valued it at $200,000, the IRS would peg its taxable worth at $180,000.

A collector would also be required to submit appreciated artwork valuations to the IRS's long-established art advisory panel for approval, the people familiar with the negotiations said.

On the other hand, the senators' revision would extend the 10-year deadline for a donor's complete divestment of artwork to 20 years, so long as the donor's initial gift was at least 10% and reached 20% within 10 years, these people said.