An accountant colleague of mine recently consulted me on a case in which his client, a retired widower in his eighties, had to reevaluate his entire estate plan because of the tax impact of the rapid appreciation of two sculptures over the course of a decade.

When the estate plan was originally drafted, the client's art collection was valued at about $5 million, one-third of his taxable estate. The estimated tax on his estate, including the collection, was $4,500,000. This amount could have been paid out of the client's liquid assets or the second-to-die insurance policy on him and his late wife. The policy was owned through a trust.

Two small bronze pieces by a modern sculptor accounted for 80% of the value of his collection. Emotions and other unpredictable elements may suddenly drive art prices up or down, when a famed artist suddenly becomes "hot." This artist did. The prices of these sculptures heated up dramatically. But the collector and his financial advisors had created a traditional estate plan that did not anticipate rapid changes in the pieces' value, and put a well-intentioned estate plan at risk.

In this case, at several public auctions similar pieces by the artist sold for more than $16 million. The new value of the two sculptures brought the estate-tax estimate up to $5.9 million on one piece alone. All the client's liquid assets and insurance would not be enough. The collector was considering selling the collection to reduce his tax burden.

The value of a collection is only partly market driven. Cultural tastes change, and with them the value of clients' precious pieces. Not taking this into account, and not using a specialist, can hurt the estate plan.

EMOTIONAL ATTACHMENTS

Disposing of a collection, though, raises an important consideration not typically covered by traditional estate plans-the issue of ownership.

Serious collectors of art, coins and other so-called unique assets often have strong emotional attachments to their treasures. Determining their "value" is more than a financial calculation. As a result, whereas investors-i.e., those with unique assets but no strong emotional attachments to them-may allocate about 10% of their portfolio to unique assets, for collectors, the weight they place on the ownership of these items can skew the allocation process.

In the case of this octogenarian art collector, he and his accountant ultimately needed to figure out how they could save his collection-so he could enjoy the artwork in his living room during his remaining years, and prevent it from being sold upon his death.

The situation that this art collector and his accountant found themselves in is all too common. Most clients and advisors tend to treat collections as an afterthought in financial and estate plans: They leave them out or include them only at the last minute. Unique assets are usually lumped in with the "other tangible personal property" of a financial plan, which either do not appreciate in value (for example, most furniture) or actually depreciate with time (say, the family car). The result is that, rather than acknowledging that artwork or collections need management as long-term investments, the plan assumes that the values will remain static, and that there will be no issue with managing the distribution or sale of the property at the death of the client.

INVESTOR OR COLLECTOR

Planners and advisors need to learn how to recognize when their clients have reached the tipping point between investor and collector. The key is that the collector wishes to own the artwork and control the future ownership of the artwork, based on his or her principles.

As soon as a client says, "I want my collection to go to ..." or something similar, whether it is to a family member or a charity, then that desire to control ownership is as important to the client as the assets-and must be incorporated into the overall financial plan. If possible, the collection should be organized into a program separate from but parallel to the investment assets. This includes inventory and provenance requirements of the assets, the significant business relationships on buying, selling and growing the value of the assets, the storage and moving assets, and the copyright and ownership control over the collection.

By the same token, advisors should be attuned to when a client expresses a desire to sell a collection. Planning and managing the liquidation of unique assets is as complex as preserving them.

Most financial planning revolves around wealth replacement. For example, many plans try to replace the taxes that will be paid out of investments with life insurance proceeds that aren't subject to estate tax. A dollar is a dollar no matter where you hold it-the investments are fungible, and the actual ownership of an asset isn't really relevant. What is relevant is the client's overall wealth.