In the Beginning
From the dawn of recorded history, those who have the means have purchased or otherwise financed the work of those whom we call artists – talented individuals capable of producing what we call works of art, but who are often bereft of any means.
In doing so, a symbiotic relationship has developed by which the former became patrons of the arts, which redounded not only to the benefit of artists, generally, but to society as a whole.[i]
Business owners were among the first patrons,[ii] and although they continue to play this role, they also realize that works of art may represent a wise long-term investment – an asset class, if you will – in which to invest some of their profits or disposable cash, and to help diversify their portfolio.
Whether intentionally or not, the Code has assisted many of these business owners with their investments in art, including the disposition of their collections, whether for charitable or other purposes.
Recent events, not the least of which is the presidential campaign, have highlighted some of the benefits bestowed by the Code upon business owners and investors, generally, and have sparked a debate over whether the Code should be employed in this manner.
Many have pointed to the “revelations” made in the recent New York Times[iii] report regarding Mr. Trump’s income tax returns as evidence of how the Code is chock-full of provisions[iv] that only benefit the “wealthy.” Included on the list of vile villains are the checkered charitable easement, the depraved depreciation deduction,[v] and the loathsome like-kind exchange.
The press and the general public reacted to the article’s contents with what may be described as moral indignation, and even outrage.
On the same day as the NYT report, the Daily Beast reported that Botticelli’s[vi] “Young Man Holding a Roundel” (the “Painting”)[vii] is to be offered for sale at an anonymous online auction early next year.[viii] According to this article, the “billionaire Manhattan art collector Sheldon Solow bought” the Painting in 1982 for $1.3 million.[ix]
One week later, Bloomberg reported[x] that 99% of this Painting was owned by a private operating foundation organized in 1991 by “New York City real estate tycoon,” Sheldon Solow – the Solow Art & Architecture Foundation (the “Foundation”).[xi]
Almost in passing, the article tells us that, over the course of years, Mr. Solow made gifts of fractional interests in the Painting to the Foundation, leaving him[xii] with only a 1% interest. These gifts would have generated income tax deductions,[xiii] the article states, which would have sheltered a portion of Mr. Solow’s otherwise taxable income.[xiv]
According to the latest federal tax return filed by the Foundation that is available for public inspection (the “Tax Return”),[xv] the Foundation was organized to maintain and display “artwork for exhibition to the public at the 9 West 57th Street, New York building.”[xvi]
The Foundation is registered at this address, and the building in question is known as the “Solow Building,” an iconic New York City office tower that Mr. Solow owns and manages.[xvii]
In addition to the Painting, the Foundation owns twelve more major works of art[xviii] with a reported fair market value (exclusive of the Painting) of approximately $260 million in the aggregate.[xix]
The Bloomberg article indicates that Mr. Solow “plans to sell [the Painting] for more than $80 million” – the Tax Return reports the fair market value as $84.15 million[xx] – and explains that such a “windfall” would normally “result in at least a $33 million capital gains tax bill”[xxi] if sold by an individual investor.
However, the article continues, “because Solow routed [the Painting] through his private foundation, he’ll owe a fraction of that amount – and has already saved millions on his personal income taxes over decades.”[xxii]
Needless to say, neither the press nor the general public took notice. They couldn’t care less.
Indeed, on the face of it, there seems to be no reason for them to care – at least for now – because the tax consequences arising from Mr. Solow’s gifting of fractional interests in the Painting to the Foundation, and from the Foundation’s anticipated sale of the Painting, are within the parameters of what the Code historically has allowed, and even encouraged.[xxiii]
The Tax Benefits
In order to appreciate the tax planning manifested by Mr. Solow’s use of the Foundation, as well as some of the issues this may present, it would help the reader to have some basic knowledge of: the deduction allowed by the Code for charitable contributions of art; and the contributor’s relationship to the recipient of such art where such recipient is a private foundation.
In general, the Code allows a taxpayer to claim a deduction for a charitable contribution of property in determining their income tax liability for the year in which the contribution is made.[xxiv]
A charitable contribution is one that is made to a domestic corporation or trust that is organized and operated “exclusively” for “charitable” purposes,[xxv] no part of the net earnings of which inures to the benefit of any private individual, which is not overly engaged in lobbying activities, and which does not participate or intervene in political campaigns.[xxvi]
However, the Code may reduce the amount of the deduction depending upon the nature of the property contributed and the character of the recipient charitable organization.
Specifically, the contributor’s deduction will be limited to their adjusted basis in the property[xxix] – in the case of non-depreciable property, such as artwork, the original purchase price for the artwork – if:
- The gain realized on a sale of the property by the contributor would have been short-term capital gain;[xxx] or
- The contribution consists of tangible personal property, such as art, and the recipient organization’s use of the property is unrelated to the purpose or function that constitutes the basis for the organization’s tax-exempt status;[xxxi] or
- The recipient organization is a non-operating private foundation.[xxxii]
Thus, a contribution of art to a tax-exempt private operating foundation[xxxiii] that operates a museum, for example, will “usually” entitle the contributor to a deduction equal to the fair market value of the art at the time of the contribution,[xxxiv] provided the contributor’s holding period for the art contributed exceeds one year. What’s more, the contributor will not be required to recognize the appreciation (or built-in gain) inherent in the property.
“Usually” entitle? Yes, there is one more, fairly significant, factor to consider: gifts of fractional interests.
In general, the Code does not allow a deduction for a charitable contribution of a partial interest in property, such as art.[xxxv] However, a gift of an undivided portion of the contributor’s entire interest in a work of art generally is not treated as a nondeductible gift of a partial interest in property.[xxxvi]
For this purpose, an undivided portion of a contributor’s entire interest in the artwork must consist of a fraction or percentage of each and every substantial interest or right owned by the contributor in the artwork, and must extend over the entire term of the contributor’s interest in the artwork.[xxxvii]
A gift is generally treated as a gift of an undivided portion of a contributor’s entire interest in the artwork if the recipient organization is given the right, as a tenant-in-common with the contributor, to possession, dominion and control of the artwork for a portion of each year appropriate to its interest in the artwork.[xxxviii]
It should be noted, however, that a charitable contribution deduction will generally not be allowed for a contribution of a future interest in tangible personal property, including artwork.[xxxix] A “future interest” is one in which the contributor purports to give the art to a charitable organization, but has an understanding or agreement with the organization which has the effect of reserving to the contributor a right to use, possession or enjoyment of the artwork.[xl]
For example, a contribution of an undivided 25% interest in a painting with respect to which the recipient organization is entitled to possession during three months of each year will be treated as made upon receipt by the organization of a formal deed of gift – however, the period of initial possession by the organization may not be deferred for more than one year.[xli]
In addition,[xlii] if a contributor makes an initial fractional contribution of an interest in a work of art, then fails to contribute all of their remaining interest in such artwork to the same organization before the earlier of (i) 10 years from the initial fractional contribution, or (ii) the contributor’s death, then the charitable income tax deductions for all previous contributions of interests in the item will be recaptured (with interest).[xliii] Likewise, if the recipient organization of a fractional interest in a work of art fails to take substantial physical possession of the item during the period described above, or fails to use the property for a related exempt use[xliv] during the period described above, then the contributor’s charitable income tax deductions for all previous contributions of interests in the artwork will be recaptured (with interest).[xlv]
In any case in which there is a recapture of a deduction as described above, the Code also imposes an additional tax in an amount equal to 10% of the amount recaptured.[xlvi]
What’s more, no income tax charitable deduction is allowed for a contribution of a fractional interest in an item of art unless, immediately before such contribution, all interests in the art are owned (1) by the contributor, or (2) by the contributor and the recipient organization.
Finally, the value of a contributor’s charitable deduction for the initial contribution of a fractional interest in a work of art will be determined based upon the fair market value of the artwork at the time of the contribution of the fractional interest and considering whether the use of the artwork will be related to the recipient’s exempt purposes; however, for purposes of determining the deductible amount of each additional contribution of an interest in the same work of art, the fair market value of the artwork will be the lesser of: (1) the value used for purposes of determining the charitable deduction for the initial fractional contribution; or (2) the fair market value of the artwork at the time of the subsequent contribution.[xlvii]
As indicated above, a contribution of art to a standard private foundation will not generate a fair market charitable deduction for the contributor; the same gift to an operating foundation, however, is treated differently.
A private operating foundation is a kind of private foundation, meaning that it is not treated as a public charity for most purposes under the Code – generally speaking, it does not derive a sufficient portion of its revenues from the general public.[xlviii]
Unlike most private foundations, however – the activities of which are by-and-large limited to making grants to publicly-supported charities which directly engage in charitable activities – an operating foundation makes a statutorily prescribed level of expenditures directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated, and substantially more than half of its assets are devoted directly to such activities.[xlix]
In other words, an operating foundation acts more like a public charity than like a private foundation. For that reason, a contributor who makes an otherwise qualifying contribution of tangible personal property – such as art – to an operating foundation, will be entitled to claim a fair market value deduction therefor.[l]
In addition, an operating foundation is not subject to the excise tax imposed by the Code in the case of a grant-making foundation that does not satisfy the prescribed minimum expenditure requirements.[li]
That being said, an operating foundation remains subject to the other excise taxes applicable to private foundations, generally.[lii] These excise taxes seek to influence the foundation’s decision-makers by dissuading them from engaging in certain “improper” activities, and by encouraging them to engage in others.
In the case of an operating foundation that engages in museum-like activities, the excise tax on acts of self-dealing,[liii] and the risk of private inurement, both feature prominently, especially where the foundation (i) holds fractional interests in the artwork acquired from its founder, or (ii) displays the artwork on properties related to the contributor or to businesses controlled by the contributor.
Because of these concerns, it is not unusual for such operating foundations (“OF”) to request private letter rulings from the IRS to the effect that their arrangement with the contributor or a related entity does not constitute an act of self-dealing. The following scenario is fairly representative.
OF is an operating foundation that was organized by DP. OF owns artwork, including sculpture. Most of the artwork was contributed to OF by its founder, though some if it was independently acquired. OF was organized to promote and develop the general public’s interest in art. Its operations are located in a complex of office buildings. OF’s sculptures are exhibited outdoors and are at all times accessible to the general public. Some of these works sit on property owned by disqualified persons (including DP).
Works of art that are not suitable for external viewing are displayed by OF in building lobbies, building courtyards or public entrances, open spaces, and rights of way. Some of these buildings are owned by disqualified persons and others are not. All of this artwork is accessible to the public for viewing during business hours. The artwork is not displayed in private offices, or in areas that are not generally accessible to the general public.
Works of art that are not on display at the office complex are either on loan to various museums or universities, or are stored with an unrelated storage company that is experienced and equipped to handle such objects.
Artworks may be viewed by the general public by taking a guided tour provided by OF. Members of the public can also view the works on their own by walking through public thoroughfares, from which they can view certain pieces of art.
There is no evidence that any of the artworks are identified with any disqualified person; rather, they are considered a cultural asset of the “community.”
The Code imposes an excise tax on each act of self-dealing between a “disqualified person” and a private foundation.[liv]
The term “disqualified person” means, with respect to a private foundation, a person who is, among other things, a substantial contributor to the foundation, a foundation manager, or a member of the family of such a person. It also includes a partnership or a corporation in which a substantial contributor or a foundation manager owns equity in excess of a statutorily-prescribed limit.[lv]
According to the Code, “self-dealing” includes any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation.
The fact that a disqualified person receives an incidental benefit from the use by a foundation of its assets will not, by itself, make such use an act of self-dealing.[lvi] Thus, for example, the public recognition a person may receive, arising from the charitable activities of a foundation to which such person is a substantial contributor, does not in itself result in an act of self-dealing since, generally, the benefit is incidental.
In the fact pattern described above, OF displays a number of artworks in building lobbies, building courtyards, building entrances, open spaces, and rights of way. None of the artwork is displayed in private offices or in areas not generally accessible to the general public. In addition, only some of the artworks are displayed on properties owned by disqualified persons.
Under these facts, OF has probably not engaged in an act of self-dealing, provided disqualified persons have neither retained control over public access to the artworks, nor retained direct use of such artworks.
The primary beneficiaries of OF’s collection are the general public who view such artworks, and any benefits to disqualified persons are probably incidental.[lvii]
Coming Full Circle, or Roundel[lviii]
The Solow Art & Architecture Foundation is only one of many operating foundations in New York City, and throughout the country, through which real estate developers and operators, who may also be avid art collectors, share their collections with the general public.
By contributing their art collections to operating foundations, and by complying with the Code’s and the IRS’s requirements for maintaining their tax-exempt status and for avoiding the imposition of foundation excise taxes, these individuals lose a significant degree of control over the art, and subject their “relationship” to the art to public scrutiny, not only by the IRS, but also by a state’s attorney general, the public,[lix] and by the local press.[lx]
Although they certainly receive a tax benefit in exchange for transferring their art to a foundation, in the form of a not insubstantial income tax deduction, they forfeit the right to derive any economic benefit from the sale or other disposition of such art.[lxi] Judging by the appreciation in the value of the Painting, this is no small sacrifice.
Moreover, in the case of artwork, the contributor’s costs in preserving and restoring the artwork do not end with the transfer of the property to an operating foundation. Who else is going to pay to insure the artwork and to store it properly? Who will compensate a curator to care for it?
As we have stated many times on this blog, Congress often uses the Code as a tool for influencing the behavior of taxpayers. At some point, Congress decided that society would benefit from making works of art available to the general public.[lxii] It has chosen to promote the transfer of art from private individuals to the public by granting an income tax deduction in exchange for such a transfer. There is a quid pro quo – think of it as a private-public partnership.
The fact that art organizations like the Foundation exist, indicates that the above policy, as embodied in the Code, is working. Yes, the “wealthy” contributor receives a benefit, but so does the public.[lxiii] If “we” decide that the public should have greater access to the art, then Congress should impose more conditions on the contribution, but it should not eliminate the deduction lest it dissuade future contributions.
[i] These patrons had varying motives for their largesse. Initially, patrons may have acted to appease or honor a deity, or to glorify a city-state. Later, some acquired art to adorn their homes for their own pleasure. Others utilized their patronage to impress a segment of society, and to thereby gain “legitimacy” in more “sophisticated” circles.
[ii] The Medici were bankers.
[iv] “Loopholes” they call them, though I don’t always understand why. I’ve always understood the term to mean an ambiguity in the law, or a gap in the law’s coverage, such that one may avoid the intended effect of the law without actually violating the law.
[v] When last I checked, the blue collar worker in the neighborhood in which I grew up, in the Bronx, who owned the attached two-family house in which they lived, was entitled to claim deductions for depreciation (and other expenses) attributable to the rental portion of the building, without which they could not afford to keep that house.
[vi] Whose patrons were none other than the Medici.
[vii] You would know it if you saw it. It doesn’t do anything for me. Must be my peasant roots.
[ix] It has been on loan to the Metropolitan Museum of Art in NYC over the last several years.
[xi] It received its so-called “determination letter” (i.e., recognition of its tax-exempt status under IRC Sec. 501(c)(3)) from the IRS in 1991. Mr. Solow is the president of the Foundation, his son is Vice President, and the CFO of his business, Solow Realty & Development Group, is the CFO of the Foundation.
To view the Foundation’s annual federal income tax return, on IRS Form 990-PF, Return of Private Foundation, visit https://www.guidestar.org/profile/13-3614971 .
[xii] Or perhaps a trust for family members?
[xiii] The “book value” reported on the balance sheet of a private foundation’s 990-PF, Part II, reflects the “cost,” or fair market value, of the property at the time it was acquired by the private foundation. In the case of a gift of artwork (which is not depreciable), the beginning and ending book values should be the same.
The Foundation’s book value for its 99% interest in the Painting is approximately $60 million.
[xiv] Indeed, the size of the interest gifted in a particular tax year may have been dictated by, and tailored to, Mr. Solow’s expected income tax liability for that year.
[xv] For the tax year ending November 30, 2018. IRC Sec. 6104 requires that an organization described in IRC Sec. 501(c)(3), and exempt from federal income tax under IRC Sec. 501(a), make its annual tax return, as well as its tax-exemption application (on IRS Form 1023) and IRS determination letter, available for public inspection.
[xvi] In fact, paintings may be seen through the glass wall on the building’s ground floor – if you know to stop and look.
[xvii] You may know it by its sloping façade and the large red sculpture of the number “9” in front of the building. https://www.google.com/maps/uv?pb=!1s0x89c258f0a616f09d%3A0xd8f0bdcadcfe72ad!3m1!7e115!4shttps%3A%2F%2Flh5.googleusercontent.com%2Fp%2FAF1QipMoDALcZH5oybqyMeVVJc2vuJMK3e-jKLHTji9k%3Dw373-h200-k-no!5ssolow%20building%20nyc%20-%20Google%20Search!15sCgIgAQ&imagekey=!1e10!2sAF1QipN4qmnPLjUaPQGSbxOLJhDbzgn-3avg3KB5c8gl&hl=en&sa=X&ved=2ahUKEwjZmqbTmb7sAhUngnIEHSRxDTAQoiowE3oECA4QAw
[xviii] Including works by Van Gogh, Matisse, Miro, Lichtenstein, and others.
[xix] According to the Tax Return, Miro’s Triptych alone is worth $60 million.
[xx] An average annual return of 11.6%.
[xxi] According to the Foundation’s tax return, the painting had a fair market value of in excess of $84 million at the end of November 2018. It was purchased for approximately $1.3 million. Thus, the gain from its sale would be $82.7 million. The federal tax rate on the sale of collectibles by an individual is 28%. Then there are NY State and NYC personal income taxes, at the rate of 8.82% and 3.876%, respectively. And don’t forget the 3.8% federal surtax on net investment income (which the article may have omitted). That brings you to a tax in excess of $36 million.
Prior to the 2017 Tax Cuts and Jobs Act (P.L. 115-97), investors in art had the opportunity to defer the recognition of gain from the sale of artwork – and possibly avoid the income tax altogether, thanks to the basis step-up at death under IRC Sec. 1014 – by engaging in a like-kind exchange under IRC Sec. 1031. The Act eliminated this option.
[xxii] Referring to the fractional gifts. https://www.bloomberg.com/news/articles/2020-10-07/botticelli-sale-to-save-solow-33-million-in-capital-gains-tax .
Of course, as a tax-exempt organization, the Foundation will not be subject to income tax on the gain it realizes from the sale of its 99% interest in the Painting. IRC Sec. 512(b)(5).
[xxiii] The same way that depreciation deductions and like kind exchanges are.
[xxiv] IRC Sec. 170(a). This deduction is treated as an itemized deduction. Thus, the amount of the deduction may be limited in the case of higher income taxpayers. IRC Sec. 68.
In addition, in the case of an in-kind contribution of capital gain property to a public charity or to an operating foundation, the amount of the deduction for the year in which the contribution is made cannot exceed 30% of the contributor’s adjusted gross income. IRC Sec. 170(b)(1)(C). Any excess may be carried forward up to five years.
[xxvi] IRC Sec. 170(c)(2).
[xxvii] Property other than money.
[xxviii] IRC Sec. 170(e).
[xxix] Unless the fair market value is lower.
[xxx] IRC Sec. 170(e)(1)(A).
[xxxi] IRC Sec. 170(e)(1)(B)(i). In addition, in certain cases, the recipient organization must not dispose of the property during the taxable year in which the contribution was made.
[xxxii] IRC Sec. 170(e)(1)(B)(ii).
[xxxiii] IRC Sec. 170(b)(1)(F) and Sec. 4942(j)(3).
[xxxiv] A qualified appraisal is required. IRC Sec. 170(f); Reg. Sec. 170A-13, Sec. 1.170A-16, and Sec. 1.170A-17. In addition, IRS Form 8283, Noncash Charitable Contributions, must be completed by the contributor, the qualified appraiser, and the recipient organization. See also Form 8282, Donee Information Return.
[xxxv] IRC Sec. 170(f)(3)(A).
[xxxvi] IRC Sec. 170(f)(3)(B).
[xxxvii] Reg. Sec. 1.170A-7.
[xxxviii] Reg. Sec. 1.170A-7.
[xxxix] IRC Sec. 170(a)(3).
[xl] Reg. Sec. 1.170A-5.
[xli] Reg. Sec. 1.170A-5.
[xlii] Effective for contributions made after August 17, 2006. P.L. 109-280, the “Pension Protection Act of 2006.”
Query whether all of Mr. Solow’s fractional gifts preceded the change in the law?
[xliii] The contributor cannot change their mind.
[xliv] If, for example, an art museum described in Section 501(c)(3) of the Code, that is the recipient of a fractional interest in a painting, includes the painting in an art exhibit sponsored by the museum, such use generally will be treated as satisfying the related-use requirement.
[xlv] IRC Sec. 170(o).
A contribution occurring before the date of enactment is not treated as an initial fractional contribution for purposes of this rule. Instead, the first fractional contribution by a taxpayer after the date of enactment would be considered the initial fractional contribution, regardless of whether the taxpayer had made a contribution of a fractional interest in the same item of tangible personal property prior to the date of enactment.
[xlvi] IRC Sec. 170(o)(3)(B).
[xlvii] In other words, the contributor cannot benefit from the appreciation in the artwork after the initial fractional interest therein is gifted to the charitable organization.
[xlviii] IRC Sec. 509(a).
[xlix] IRC Sec. 4942(j)(3).
[l] IRC Sec. 170(e)(1)(B)(ii).
[li] IRC Sec. 4942(a).
[liv] IRC Sec. 4941(a).
[lv] IRC Sec. 4946.
[lvi] Reg. Sec. 53.4941(d)-2(f)(2).
[lvii] In contrast, in Rev. Rul. 74-600 the IRS considered a situation in which a private foundation placed three paintings in the residence of a disqualified person, where they were displayed with the disqualified person’s large private art collection. Semi-annual tours (and other “special” tours) were conducted, on which over 2,000 persons viewed the paintings. It was held that, even though the paintings were sometimes made available for viewing by the public, the placement in the residence of a disqualified person resulted in a direct use of the foundation’s assets by or for the benefit of the disqualified person, and was therefore proscribed self-dealing under the Code. The outcome was not dependent on the number of people who viewed the art, or the frequency of such viewing, since the disqualified person retained control over public access to the paintings.
[lviii] I couldn’t resist. Apologies.
[lix] Again, just visit Guidestar.org.
[lx] Turning back to Mr. Solow, in January 2019, the Solow Building Company officially began leasing its residential rental and condominium property at 685 Third Ave., in New York City.
According to one article describing the new building, “the triple height lobby space will greet residents, with . . . a three-paneled masterpiece design by Joan Miró, borrowed from Sheldon Solow’s personal art collection, to be located on the back wall of the lobby. Of course, this is the same Miro identified on the Foundation’s balance sheet for the tax year ending November 2018. ”https://newyorkyimby.com/2019/01/sales-launch-for-solows-685-first-avenue-in-midtown-east-manhattan.html; https://www.crainsnewyork.com/article/20180511/REAL_ESTATE/180519974/sheldon-solow-using-joan-mir-oacute-paintings-from-his-tax-exempt-foundation-to-sell-condos-on-first-avenue .
[lxi] For example, many a collector has pledged their works of art as collateral to secure loans from unrelated lenders.
[lxii] That is why museums are generally exempt from tax.
[lxiii] At least in theory.