Say that you have an extra Monet or a Warhol hanging around your house and you decide that you would like to donate it to your favorite local museum to share it with the public; but, for sentimental reasons, you do not want to fully part with it at this time. So, you plan to give the museum a 25% interest in the painting now and will give the remaining fractional interest in the painting to the museum in installments over time. You think this is a great idea because you are not only sharing this fabulous painting with the public, but you may retain the painting in your home (for a percentage of the time) and you will be entitled to a charitable income tax deduction for the donation. Unfortunately, no good deed goes unpunished. You have just opened yourself up to tangled web of income tax rules that discourage fractional interest gifts of art to charitable organizations.

Let’s assume that the Monet that you plan to give to the museum is currently worth $10 million. When you make the first fractional gift of a 25% interest in the painting to the museum, the value of the charitable income tax deduction for this fractional gift is worth $2.5 million (i.e., 25% of the current fair market value of the painting). Several years later, you make another 25% gift of the Monet to the museum when the Monet is worth $20 million. You are correct if you guessed that your charitable deduction for the gift of the second installment of the painting is not worth $5 million (i.e., 25% of the current fair market value of the painting). Section 170(o) of the Internal Revenue Code (IRC) limits the value of subsequent fractional interest gifts of art to charity to the percentage of the art given multiplied by the smaller of: (1) the fair market value of the art valued at the date of the initial installment gift or (2) the fair market value of the art at the time of the additional contribution. Therefore, the charitable deduction for the second 25% installment gift of the Monet is worth $2.5 million (i.e., 25% of the fair market value of the painting as valued on the date of the initial fractional gift) instead of $5 million.

In addition to the income tax charitable deduction valuation rules for fractional gifts of art discussed above, IRC Section 170(o) also requires that:

1.         Immediately before the contribution, the art is owned entirely by the donor or by the donor and the charity;

2.         The art must be fully contributed to the charity before the earlier of (a) 10 years after the initial contribution, or (b) the date of the donor’s death;

3.         The charity must take substantial physical possession of the art; and

4.         The charity must put the art to a “related use.” This means a use related to the charity’s tax exempt purpose; however, the charity violates the related use rule if it disposes of the art within three years after it receives the gift. An exception applies if the charity certifies that the art was put to a related use or that it became impossible to do so.

If any of the rules with respect to the timing of the gift, the charity’s physical possession requirement or the related use rule are violated, then all previous income tax benefits received by the donor are recaptured (i.e., the value of past charitable income tax deductions are converted into taxable income for the donor), with interest, and an additional 10% penalty is applied.

Given the restrictive rules applicable to fractional interest gifts of art to charity, why would anyone want to do this? Indeed, these rules have substantially reduced the number of fractional interest gifts made to charities. However, if someone is unable to use the entire charitable income tax deduction for the contribution of the entire piece of art to charity (within the time frame allotted by the IRC), it makes sense to consider making fractional interests of gifts of art to a charity over a ten year period.

If you would like to discuss this or other trusts and estates issues, please contact the attorneys at Drucker Law Offices, 468 North Camden Drive, 2nd Floor, Beverly Hills, CA 90210, 310.285.5375 Tel, 310.444.9754 Fax, www.druckerlaw.com