Artful Giving: Donating Collectibles for Good

In the coming decades, baby boomers and the silent generation are projected to pass on a staggering $72.6 trillion in assets to their heirs.¹ This massive wealth transfer will include collections of art, jewelry, cars, coins, and other “passion assets.” But what if younger generations don’t share the same enthusiasm for the older generation’s tangible treasures?

Instead of burdening heirs with the complexities of managing these assets, collectors might consider transforming them into meaningful philanthropic contributions. Our recent research examined the financial outcomes of such choices and found the approach highly beneficial. For many collectors, the emotional value attached to certain pieces makes it even more crucial to plan thoughtfully for the future and legacy of their collections.

When donors think about making charitable gifts, cash and marketable securities are usually the first things that come to mind. In fact, gifts of publicly traded securities have historically made up over 53% of annual contributions to donor-advised funds (DAFs).² Meanwhile, other types of tangible assets—like artwork or a rare coin collection—are often overlooked. While these assets can be more complex to donate, they can be particularly effective, especially if their value remains stable during market fluctuations. Generally, there are three main strategies for donating passion assets:

1. Sell the asset and donate the after-tax proceeds to a charitable organization.
2. Donate the asset directly to a charity for related use.
3. Donate it to a DAF or charity for non-related use.

From an income tax planning perspective, collectors and inheritors should carefully evaluate the trade-offs between securing a more favorable income tax deduction and putting more dollars to work supporting their favorite causes. 

First, Understand the Tax Implications

Charitable Income Tax Deductions 

One reason donating collectible assets is less common is the limited charitable income tax deduction available to many donors. For instance, if a collectible asset is donated in kind to a DAF or nonoperating private foundation, the deduction is based on the lesser of cost basis or fair market value (FMV). A more favorable deduction may be obtained if the asset is donated directly to a public charity or operating foundation³ that can use the asset in its normal operations for its tax-exempt purpose instead. Here, think of gifting artwork to a fine art museum that will then display it. This is known as the IRS’s “related use” rule.

If the gifted asset qualifies for related use by the recipient charity, the donor may receive the higher FMV deduction, provided the asset has been held for investment purposes for at least one year. But if the charity does not use the donated asset as part of its charitable purpose, it is considered non-related use, and the tax deduction is limited to the lower of FMV or cost basis. It is important to note that the IRS requires a qualified appraisal for any tax deduction claims of $5,000 or more for collectible assets. What’s more, any deduction is also subject to adjusted gross income (AGI) limitations. Given these nuances, it’s crucial to consult your tax or legal advisor on your specific circumstances.

What if the collectible is artwork and the collector happens to be the artist? In that case, the artist can only deduct the cost of the physical materials used to create the piece—even if it’s displayed in a museum or art gallery. Below we outline the IRS rules for tax deductibility according to charitable entity recipient and the type of contribution. 

Minimizing Capital Gains

When a collector or inheritor sells a collectible asset, they must pay capital gains tax on the difference between the cost basis and the FMV. But how is the cost basis determined? For collectors, it’s the price paid to acquire the asset, which must be held for longer than one year to qualify for the more favorable long-term capital gains tax treatment. The cost basis for inheritors, on the other hand, is typically stepped up to the FMV as of the previous owner’s date of death, and these assets are considered long- term regardless of how long the deceased owned them.

The maximum capital gains rate for collectibles is 28%, with the Affordable Care Act layering on an additional 3.8% surtax, for a maximum effective rate of 31.8%. This is higher compared to the maximum federal capital gains tax rate of 23.8% for traditional long-term assets like common stock. In other words, the avoidance of capital gains from donating a collectible asset can lead to significant tax savings—and potentially higher proceeds that may ultimately flow to charitable causes.

To gain a deeper understanding of how these three strategies affect charitable income tax deductions, capital gains tax—and, most importantly, charitable giving capacity—let’s delve into the financial implications of each approach. 

Transferring Collectibles in Practice

Matteo, an astute art enthusiast from Florida, recently learned that his collection of fine art is now valued at $1 million, despite an initial investment of just $100,000. As he worked on updating his estate plan, Matteo intended to pass down this cherished collection to his two adult children. However, during a heartfelt family meeting, his children expressed a different view. Rather than inheriting the art, they wished to leverage its value to support the family’s philanthropic goals. To explore this, the family turned to their Bernstein advisor to help evaluate the trade-offs when balancing their estate planning with their charitable aspirations. 

An Outright Sale

First, Matteo contemplates selling the collection outright and contributing the after-tax proceeds to his DAF. The downside? Matteo would face a hefty capital gains tax bill of $270,300, assuming a 5% sales commission and capital gains rate of 31.8%. This tax hit would reduce his DAF contribution to $679,700. On the bright side, since Matteo falls within the top federal tax bracket of 37%, the charitable income tax deduction would lower his federal income taxes by $251,489.³ This means the effective cost of his gift—calculated as the value of the gift minus the tax deduction benefit—would be $428,211. But is there a more tax-efficient strategy available?

Donating for Related Use

Next, Matteo considers making an in-kind charitable donation to a public charity, such as a museum that displays artwork for public enjoyment. Since this gift would pass the related use test, he could base his tax deduction on the $1 million FMV of the collection and generate a $370,000 income tax deduction. Plus, by opting for an in-kind donation, Matteo would sidestep the capital gains tax liability and the 5% sales commission. While these benefits appealed to him, he had concerns about finding an organization that would embrace his somewhat unconventional collection as part of its charitable mission. And if he couldn’t find a suitable home that qualified as related use, then his tax deduction could be limited to the $100,000 cost basis. Ultimately, Matteo liked the idea of using his charitable dollars to support a variety of causes important to his family. So, he returned to exploring his DAF as a viable option.

Donating to a DAF

Finally, Matteo evaluates donating his collection directly in kind to his donor-advised fund. How would this work? In this scenario, Matteo’s DAF sponsor would take custody of the collection and collaborate with an auction house to eventually sell it. Since the gift wouldn’t meet the related use test, Matteo would only qualify for an income tax deduction based on the cost basis, resulting in tax savings of $37,000 (his $100,000 deduction multiplied by his federal marginal tax rate of 37%). While this approach offers a lower deduction, the capital gains savings are quite compelling. Similar to donating to a museum, Matteo would avoid paying taxes of $270,300, bringing the effective cost of the gift to $692,700.

While Matteo didn’t maximize his personal tax savings in this scenario, he’d have $950,000 of proceeds available for charitable grants—40% more than if he’d opted for an outright sale. What’s more, by reinvesting the proceeds in his DAF, the assets would grow tax-free until he was ready to make future grants to the various charities he cherished. Additionally, Matteo's team of advisors, including the DAF sponsor and sales agent, possessed the expertise and resources to handle the acquisition and sale logistics on his behalf—a win-win scenario, in Matteo’s view. 

Maximize Impact, Minimize Hassle

Deciding which assets to donate in order to fund philanthropic priorities often hinges on ease and simplicity. Some charitable organizations may lack the capacity, expertise, or resources to accept and liquidate collectible assets. However, contributing such assets to a DAF can be a game-changer, as many sponsors are equipped to perform due diligence and manage any complexities that may arise.

By taking a comprehensive look at your entire balance sheet, you might discover opportunities to achieve the same or even greater charitable impact, often with added tax benefits, compared to donating cash or marketable securities. Your Bernstein advisor can assist you in analyzing your balance sheet to identify the most optimal assets for fulfilling your charitable giving goals.