NEW YORK—On August 17, a change in the Pension Protection Act went into effect that could have a profound impact on collectors’ willingness to donate a partial gift to museums. Before, when a collector “donated” 10 percent of the value of a painting worth $1 million to a museum, the donor would receive a $100,000 charitable deduction in the first year. “The way it was supposed to work was that for 90 percent of the year the painting hung on the owner’s wall and the other 10 percent at the museum,” says Phillip J. Michaels, an attorney specializing in estates and trust with Fulbright & Jaworski LLP.

One problem is that a museum might never have taken possession of the paining for 10 percent of the year, yet the donor still received a tax deduction without any public benefit. Under the old law, if the donor decided after a couple of years to donate yet another 10 percent ownership of the painting to the same museum, there would be a new evaluation and a new charitable deduction on the additional 10 percent. Owning 20 percent of the work, the museum would be able to hang the painting on its walls for 73 days—20 percent—of the year. “In the past, most museums liked this arrangement because they had a stake in the art,” explains Michaels. “Often when the donor died, the museum could receive the remaining 80 percent and have full ownership of the painting. The donor could stretch this out without any time limit.”

The revision changes all that. “Now, collectors must have an appraisal on Day One, gifting whatever percentage they wish, but the deal must be finished at the latest within 10 years from the date of the original gift or earlier if the client should die,” says Michaels. If the collector doesn’t complete the transaction within 10 years or by death, all income tax deductions previously taken will be lost, plus interest and a penalty. Michaels suggests clients avoid fractional gifts at this time.

OTHER REQUIREMENTS OF THE NEW LAW

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►The museum must have “substantial physical possession” of the partial gift. “We don’t as yet fully understand what that means,” notes Michaels.

►Any increase in the value of a work of art partially gifted is no longer relevant—even with significant appreciation, the original appraisal stands. “Yet if the work depreciates in value when a collector is ready to make a second partial gift, the collector must use the lower value for the charitable deduction,” says Michaels.

►Collectors’ estates may run into tax problems with partial gifts. “Let’s say you gave a painting worth $2 million to a museum and you gave away 50 percent while you were alive,” says Michaels. “And let’s assume that in your will you gifted the remaining 50 percent to the same museum. The problem is that the estate tax deduction is based on the original $2 million. But because of the partial gift, you have an asset in your estate worth $2 million but you are only going to get a deduction for $1 million. Your estate must then pay an estate tax on that million-dollar phantom asset.”