Giving Is Easy; Valuing is Hard
Bruce H. Barnett, J.D., LL.M. (Taxation)
Palm Beach County, Florida
You’ve spent years putting together your beloved and now valuable book collection and you’re thinking about its safekeeping once you no longer can care for it. Your significant other has begrudgingly accepted your “hobby” but has no interest in perpetuating it. And your kids never even pretended to care! You love your children but can’t trust them to care for the collection that you lovingly put together over the course of decades. What to do? The rational part of you says “sell the collection in an orderly way” because your knowledge is more likely to result in maximizing the sales proceeds than if the sale is handled by other family members. You know that once the collection passes from your hands, your heirs will be unable to realize the collection’s true value. By contrast, selling your collection while still under your control is the surest way to properly oversee its disposal. But, the prospect of breaking up your collection through measured sales is heartbreaking. Your thoughts naturally drift to another possibility, i.e., contributing the collection to an institution like a university, museum or library that will not only keep it together but will properly care for it. Thinking further, you begin identifying other benefits from a donation including developing a measure of public recognition and acclaim for your good deed, establishing a rich store of material for research by academicians, facilitating exhibitions for public education by institutions, and generating estate and income tax savings.
Having determined that a contribution to an institution is at least a reasonable possibility worthy of further merit, you begin digging a bit deeper into the matter. One of the things you’ll find is that your objective of preserving your collection wholly intact directly conflicts with the institutions’ desire for flexibility to allow the collection to be dismantled, in whole or part, under certain circumstances. A common compromise allows institutions to dispose of “duplicates” but otherwise to retain the collection.
You’ll soon bump into a series of important yet subtle tax issues, the trickiest and most consequential of which is establishing the value of the collection. The importance of this valuation issue represents the core of the discussion that follows. Note that while antiquarian books are emphasized below, generally the principles described are applicable equally to other forms of art and antiques.
An understanding of some of the fundamentals is helpful in analyzing the tax consequences of charitable contributions. A useful starting point is the set of rights afforded to creators of artistic works by the copyright laws of the United States. Those rights are in the form of protections provided by Title 17 of the United States Code to authors of “original works” including literary, dramatic, musical, artistic and other intellectual works. The owner of the copyright has the exclusive right to reproduce the work, to distribute copies and to display the work. These rights can be lawfully transferred by the copyright owner. Such transfers in the context of books, however, are rare. More often, the owner of a lawfully obtained copy of a book has limited rights that allow the book to be resold and displayed and to be transferred to its next owner along with those limited rights. While the copyright laws do not apply to all antiquarian books because of their old age, many are young enough to be subject to the copyright provisions. The rules governing the term of copyright protection are too complicated to cover here but are important for collectors and booksellers to understand should they intend to use their books for purposes beyond simply buying, selling and displaying.
This cursory discussion of copyright principles is relevant because the value of a particular work of art may be determined in part by the range of options available to the owner. Thus, the owner of a single copy of a book may have a property worth far less than the owner of the right to reproduce that work and sell copies in prodigious quantities.
When a contribution is made to an institution like a museum, library or university, the value of the gift must be established for use on tax returns. That amount is called the “fair market value”, defined as the price at which an item will change hands between unrelated parties where both are knowledgeable about it and neither the buyer nor the seller is obliged to act. This conception eliminates values used in transactions that may not be at “arm’s length”, e.g., between relatives where the price may not reflect true economic value. Also excluded from consideration are transactions where one party can take advantage of the other through superior knowledge and where one party must act because of economic necessity or legal requirements. To illustrate these points, imagine that a collector has contributed a copy of the 1894 Kelmscott Press edition of The Complete Poems of John Keats to a university library and that the value of the book must be established for use on the collector’s tax return. Assume that the collector asks a member of the Antiquarian Bookseller’s Association of America (“ABAA”) to value it. The ABAA member learns that in the past year, four copies of the same book have been sold and remarkably, each copy is in exactly the same condition as the volume to be valued. The bookseller knows that in the first case, a father sold his son the book for $500. In case two, an unscrupulous bookseller purchased the book from a 95 year old widower suffering from Alzheimer’s for $350. The seller of the third book desperately needed cash to pay for his mother’s urgent surgery and quickly found and sold the old family heirloom that he knew nothing about for $400. The fourth sale occurred at a heavily advertised Sotheby’s auction where a well known William Morris collector was the winning bidder at $3,500 before buyer’s commission. Under the tax rules, the first three sales would be disregarded in favor of the fourth where both parties were knowledgeable, unrelated and under no compulsion to buy or sell. Despite three sales ranging between $350 and $500, the ABAA bookseller likely would conclude that the fair market value of the contributed book is $3,500 and that is the value that the collector should use in filing the required tax returns.
The most fundamental economic task for donors then is establishing the fair market value of the items to be contributed. The market, however, for antiquarian books is tricky. Unlike the stock market, there is no exchange available to provide a reliable and ready valuation. Moreover, unlike the stock market where one share of common stock in a company is the same as every other common share, there can be substantial variations between one copy of a book and the next. Compared to the stock market, the book market can be viewed as an illiquid venue where unique items are traded. Valuing infrequently traded and unique items can be an intimidating task.
Wall Street analysts spend enormous time and valuable resources constructing economic models to calculate the value of a company’s shares to decide whether they are over or undervalued and whether therefore to buy or sell them. These models normally are based upon an estimate of future dividends or interest that the asset is expected to generate. Such effort and expense is premised upon the notion that the worth of an asset is a function of the present value of its future cash flows. Said more simply, an investor is more likely to pay a higher price for a stock that provides $500 in cash to her in five years than another stock that will return $300 in eight years. In addition to dividends and interest, financial assets sometimes return cash in the form of capital gains representing one time payments from the disposition of the asset. Increases in value (capital gains) and decreases in value (capital losses) reflect the consensus expectation of investors about future cash that will be returned by the investment. If investors expect future cash flows to be substantial, they will bid the price of the asset higher and thereby generate capital gains. If, however, they are pessimistic about future cash flows, they will push the price down into capital loss territory.
Financial assets and antiquarian books have fundamental differences in cash flows. In the usual case, books will return cash only when sold; there are no book equivalents to periodic dividends and interest that flow from financial assets. Of course, copyright owners are positioned to benefit from the sale of additional copies but someone owning a copy has no such reproduction rights. Moreover, while owners of older books with no copyright protection can reproduce them with impunity, they have no rights of exclusivity and therefore take on extra risks in producing additional copies.
The value of a copy of a book then is reduced to the simple question of what someone is willing to pay for it without benefit of a stream of future cash flows or a readily available exchange that lists its current worth. Answering that question is far more challenging than asking it. In the absence of likely cash flows and established exchanges, one must look at comparable transactions such as the price at which the book has traded in recent sales. The more transactions, of course, the more data that is available to ascertain value. If, for example, 10 copies of Christopher Morley’s Where The Blue Begins illustrated by Arthur Rackham have sold for between $75 and $125 in the last year, another copy is likely to sell in or closely around that range. Adjustments should be made for such factors as condition, edition, association and the like. Thus, a first edition in fine condition with a delightful inscription to a famous celebrity, signed also by the illustrator and publisher would sell at the top end of the range, if not above it. By contrast, a reading copy with nothing else to commend it likely would sell at the bottom end of the range or below it.
One difficulty, of course, is establishing the price at which a book has traded. Auctions provide some information and transparency since their results often are made public. Thus, Ebay, Sotheby’s, Christies, Swann and similar auctioneers provide data that can prove useful in establishing book values. But, there are many cases where such actual sales data is unavailable. Where then does one turn for comparable transaction data? Once again, online auction sites like Ebay can provide a useful starting point as can other websites such as the one maintained by the ABAA. It is important, however, to remember that the prices listed on those sites represent the asking price and not necessarily the price at which the book will sell. In fact, stories abound of books that languish year after year on sites such as ABE suggesting that their asking price is too high and therefore not representative of fair market value. Similarly, reports of fraud and misrepresentation of books on Ebay are rampant thereby calling into question the validity of Ebay pricing.
Rarer books, of course, present even greater challenges in finding comparable transactions. How, for example, is a value established for the 1909 Richard G. Badger edition of The Legende of Sainte Cariberte Des Oies by Gertrude Hall Brownell, of which only four copies are known with three being found at Brown University, the New York Public Library and the Library of Congress? Here the judgment of a rare bookseller is needed to apply her skill and experience to extrapolate values. Among the factors the bookseller would consider are the importance of the work, condition of the book and the values at which different yet similar books have traded. The bookseller will take advantage of available tools like subscription services that, for a fee, provide a running record of past auction results as well as her knowledge of actual trades in the rare book marketplace. In valuing a collection, the bookseller also would consider whether the whole is greater than the sum of the parts, i.e., whether additional value should be included to reflect the time, ability and cost of accumulating a comparable collection.
Finally, it should be noted that rigorous IRS procedural requirements attach to the computation of the amount of a charitable contribution. Thus, the donor must attach a form to her income tax return signed by the institution acknowledging the receipt of the contribution. In addition, the appraiser must sign the form and describe her capabilities to perform the appraisal. While there are some similarities in the case of contributions to institutions made by bequest in the will of a deceased collector, the stakes tend to be different since the value of the collection is offset by the amount of the contribution in the estate tax return. Unlike lifetime charitable contributions that impact the donor’s income tax return, the value of a collection included in an estate but disposed of by charitable contribution generally will receive little IRS scrutiny since the amount of estate tax generally is unchanged regardless of the collection’s value.
Contributing a collection to an institution such as a library, museum or university is a viable option for many collectors with a number of benefits for both the donor and the recipient. Establishing the value of the contribution, however, can be a very difficult task requiring data, investigatory tools and judgment borne of experience. Inasmuch as the IRS may scrutinize the value of the collection, the stakes can be high and the outcome uncertain. Understanding IRS valuation standards and following IRS dictates increase the chances for a smooth and successful outcome.
Bruce H. Barnett is
the owner of The Book Block, an antiquarian book business located in Lake Forest, Illinois. Trained in law and finance, he holds a J.D. and Master of Laws in Taxation from the NYU School of Law and studied at the Graduate Business School at Columbia, the University of Connecticut, NYU and Michigan. He practiced finance and tax law for over 30 years and has written and lectured extensively on taxation. Contact him at