Philanthropic Planning Case Study: From Faulkner to Stull & Troye
John grew up in Lexington and was interested in art from an early age. During the 1990s, when John was in his 30’s, he became enamored with Henry Faulkner’s work. As Faulkner was well known around Lexington and folks didn’t value his pieces at the time, he was able to acquire 10 pieces for relatively little.
Fast forward 30 years and his Faulkners have appreciated significantly while John’s taste has evolved. His collection now features confirmation paintings by Richard Stone Reeves, Henry Stull and Edward Troye, among other equine artists.
John has always given to charity and makes annual gifts to the Filson Club in Louisville and Old Friends in Georgetown.
During a recent meeting with his financial advisor, John mentioned the idea of selling all 10 Faulkners, and donating the proceeds to his favorite charities.
His advisor recommended a different path. He suggested John donate the pieces to his Schwab Donor Advised Fund and then gift the proceeds from the DAF. This would allow him to avoid the 31.8% tax he would otherwise owe on the sale of the art (28% capital gains rate on art and 3.8% net investment income tax)
Breaking down the options:
Option 1: John sells the paintings on his own, pays capital gains taxes on the appreciation, pays the sales expenses, and then donates the remainder to charity.
Option 2: John donated the paintings to his Donor Advised Fund, who then sells the painting for him. When the paintings have sold, John can donate the proceeds to charity.
The difference between the two is pretty drastic. Donating the paintings to the DAF is a net tax benefit, whereas selling and then donating the proceeds ends up increasing John’s tax bill for the year. On top of that, John’s favorite charities will receive an additional $126,000, money I’m sure they can put to good use.
The Related Use Rule for Art Donations:
When donating art or collectibles, the IRS’s related use rule is key for determining your charitable income tax deduction. Basically, you get to deduct more of your contribution if the donated item is used by the receiving charity in a way that is related to the charity’s purpose.
For example, if you donate a piece of artwork to an art museum, you can deduct the full fair market value of the art.
If you give art or collectibles to an organization that doesn’t meet the related use rule, your deduction is limited to the lesser of the fair market value or your cost basis. Likewise, if the organization plans to sell the artwork immediately, your gift won’t count as a related use.
I showed the potential benefits of gifting through a Donor Advised Fund in the case study above, but I want to note that a big exception to using a DAF is when your gift would qualify under the related use rule. If it qualifies there, it’s usually better to give the gift directly to the organization.
For example, Anna wants to donate an early-Kentucky bandy legged chest to Locust Grove. Locust Grove, as a house museum, wants to put the piece on display. Anna bought it at a flea market for $200 and it’s currently worth $6,500.
Giving the piece directly to Locust Grove would allow Anna to deduct the fair market value of $6,500.
If she donated it to a Donor Advised Fund, she could only deduct her basis, $200.
Annual Deduction Limits for Art Donations:
I’m not going to get too deep into this. Just know that the amount of charitable deductions you can take claim each year is limited to a certain percentage of your income and that percentage is based on the type of donation. In my experience, this limit is rarely an issue. When it does come up, it’s because of an exceedingly large gift or an extremely low taxable income. In either case, any deduction that is disallowed in the current year can be carried forward for up to five years. You don’t just lose the deduction.
Qualified Appraisals for Art Donations:
While Goodwill gives blank receipts and allows you to fill in the value of goods you donated, that doesn’t work for art or collectibles.
If your donation is worth $5,000 or more, you’ll need to get a qualified appraisal by a professional and that appraisal must be included with your tax return. The appraisal should be completed within 60 days of the donation and before you file your tax return for that year, including any extensions.
If the donation is worth more than $500 but not over $5,000, the taxpayer must instead complete a Form 8283, Noncash Charitable Contribution, Section A, and attach it to their tax return.
Minimizing Estate Tax Exposure with Art Donations:
Right now, estate taxes are rarely an issue since the estate tax exemption is $13.61 million per person. As it stands, that exemption will drop to $7 million per person in 2026, at which point the number of folks affected will be significantly higher.
Art and other collectibles matter because they’re included in the gross valuation of your estate, on which your estate taxes are based. For estates exceeding the federal exemption amount, the excess is taxed at a top federal rate of 40%, excluding potential state taxes.
Donating art during your lifetime will remove it from your gross estate and can reduce your estate tax exposure.
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