Denver Law Review Volume 71 Issue 2 Article 4 January 2021 Fair Market Value, Blockage, and the Valuation of Art John G. Steinkamp Follow this and additional works at: https://digitalcommons.du.edu/dlr Recommended Citation John G. Steinkamp, Fair Market Value, Blockage, and the Valuation of Art, 71 Denv. U. L. Rev. 335 (1994). This Article is brought to you for free and open access by the Denver Law Review at Digital Commons @ DU. It has been accepted for inclusion in Denver Law Review by an authorized editor of Digital Commons @ DU. For more information, please contact [email protected],[email protected]. FAIR MARKET VALUE, BLOCKAGE, AND THE VALUATION OF ART JOHN G. STEINKAMP* INTRODUCTION ................................................... 336 I. VALUATION OF PROPERTY FOR ESTATE AND GIFr TAX PuRPosEs ............................................. 340 A. Time of Valuation ....................................... 340 B. FairM arket Value ....................................... 343 1. Price at Which Property Would Change Hands ...... 344 2. Willing Buyer and Willing Seller .................... 345 a. Hypothetical Nature of Buyer and Seller .............. 346 i. Relationship Between the Transferor and Transferee ................................... 346 ii. Identity of Willing Buyers .................... 348 3. Neither Being Under any Compulsion to Buy or to Sell ................................................ 350 4. Both Parties Having Reasonable Knowledge of Relevant Facts ...................................... 351 a. Post-Valuation Date Events and Information .......... 352 5. In a Market in Which Such Item is Most Commonly Sold to the Public .................................. 355 C. Burden of Proof and ProceduralIssues ..................... 349 D. Role of Expert Appraisers ................................. 362 E. Valuation Restraints ..................................... 363 1. Tax Court Risk ..................................... 364 2. Undervaluation Penalties ........................... 365 II. BLOCKAGE ................................................. 366 A. Recognition of Blockage ................................... 366 B. Identification of the Block ................................. 370 1. Estate Tax .......................................... 370 a. Effect of Alternate Valuation Election ................ 373 2. G ift T ax ............................................ 377 3. Reconciliation of Estate and Gift Tax Rules .......... 379 C. Transferee's Intended Use of the Property .................... 380 D. Blockage Factors ......................................... 382 1. Size of the Block ................................... 383 2. Time Required to Liquidate Without Adverse Impact on Price ............................................ 383 E. Effect of Blockage on Value ................................ 385 1. All Relevant Factors Valuation ....................... 386 * Associate Professor of Law, University of Arkansas School of Law, Fayetteville, AR; B.A, University of Illinois; J.D., University of Colorado School of Law; LL.M. (Taxation), University of Denver College of Law. DEWVER UNIVERS/TY LAW REVIEW [Vol. 71:2 2. Alternative Market Valuation ........................ 387 III. VALUATION OF ART ......................................... 397 A. Relevant Market ......................................... 399 1. Private Sales ........................................ 400 2. Gallery Sales ....................................... 400 3. Auction Sales ....................................... 401 a. Buyer's Premium .................................. 402 B. Art Appraisers and Appraisals............................. 404 C. IRS Art Advisory Panel................................... 407 IV. BLOCKAGE AND THE VALUATION OF ART ......................... 409 A. Estate of Smith v. Commissioner ........................ 409 B. IRS Valuation Guide..................................... 412 C. Calder v. Commissioner ................................ 413 D. Estate of O'Keeffe v. Commissioner .................... 418 V. CONCLUSION ............................................... 424 INTRODUCTION David Smith, Alexander Calder, and Georgia O'Keeffe expressed their artistic creativity in distinct and novel ways.' To varying degrees, each experienced the financial success that accompanies recognition of artistic merit in today's art world.2 Their status as successful artists led to a common result after their deaths: litigation over federal transfer taxes in- 3 volving the valuation of large blocks of their art. Artists and their estates confront two problems in connection with the 4 valuation of large blocks of art for federal gift and estate tax purposes. 1. See Estate of O'Keeffe v. Commissioner, 63 T.C.M. (CCH) 2699, 2701 (1992) ("O'Keeffe's diverse range of subject matters, such as flowers, trees and leaves, landscapes (New Mexico and New York), and abstractions (early and late), and her various 'periods' appealed to different segments of the public."); Estate of Smith v. Commissioner, 57 T.C. 650, 651 (1972), afftd, 510 F.2d 479 (2d Cir.), cert. denied sub nom. 423 U.S. 827 (1975) ("Most of his [Smith's] work is of the abstract, nonrepresentational variety and fashioned out of welded steel and other metals, a technique which Smith pioneered."). Robert Hughes, The Iron Age of Sculpture, TIME, May 3, 19.93, at 63, opined that: [Alexander] Calder's genius in the '20s and '30s was for making extraordinarily deli- cate and literally "wiry" sculptures that danced at a breath.... By 1951 ... [David] Smith's pre-eminence in American sculpture was complete: he could draw with steel in space with as much fluency as with pencil on paper, creating metaphors that mingle the organic and the mechanical in an unstoppable lyric eloquence.... Sculpture's iron age, in such hands, was also a golden one. Id. at 64. 2. Gallery sales of 75 of David Smith's works between 1940 and his death in 1965 grossed $218,080.50. Smith, 57 T.C. at 651-52. Georgia O'Keeffe was an extremely successful artist. The average price of paintings she sold personally reached a high of $631,250.00 in 1983 and auction sales of her works at the major houses from 1979 through 1985 totaled $4,474,000.00. O'Keeffe, 63 T.C.M. (CCH) at 2700-01. 3. O'Keeffe, 63 T.C.M. (CCH) at 2699; Calder v. Commissioner, 85 T.C. 713 (1985); Smith, 57 T.C. at 650. 4. Consideration of income tax issues that confront artists and their estates is beyond the scope of this article. See generally RALPH E. LERNER & JuoDrrH BRESLER, ART LAw: THE GUIDE FOR CoLLEcroRs, INVUSroRs, DEALERS, AND ARTISTS (4th ed. 1989 & Supp. 1992); Jef- frey C. McCarthy, Federal Income Taxation of Fine Art, 2 CAlDozo ARrs & Er. L. J. 1 (1983); Douglas J. Bell, Note, Changing I.P C. § 170(e)(1)(A): For Art's Sake, 37 CASE W. REs. L. REv. 536 (1986-87). 1994] FAIR MARKET VALUE First, individual artworks5 must be valued. Second, it must be determined whether the aggregate value of the works should be reduced because of the large number transferred or included in the estate.6 While similar issues arise in the taxation of nonartists, these issues present particular problems for artists and their estates because of the difficulties in the valu- 7 ation of art and the unique nature of the art market. The Internal Revenue Code ("Code") imposes federal estate and gift taxess on the transfer of property which are determined by reference to the value of the property transferred. 9 Value for transfer tax purposes means fair market value-"the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of 5. All references in this article to "art," "art objects," "artworks," and "works of art" are to the tangible items produced by artists. Consideration of copyright issues is beyond the scope of this article. Consequently, no attempt has been made to distinguish between art objects (tangible property) and works of art (intangible property rights). A distinction must be made between ownership of the material object in which the copyrighted work is embodied and ownership of the copyright itself. A copy- righted work may be "a literary work printed on the pages of a book," for example, or "pigment painted on a canvas, or a musical work pressed into the grooves of a phonorecord." Under today's law, sale of the material object, such as a book, paint- ing, or phonorecord of the copyrighted work, does not convey ownership of copy- right in and to that work or transfer any rights under copyright. LERNER & BRFSLER, supra note 4, at 357 (footnotes omitted); David W. Schaaf, Estate Planning for Authors and Artists, 423 TAX MGMr. (BNA) 1, A-4(1) (1990) ("A copyright is essentially an aggregation of intangible rights, including the exclusive rights of reproduction and distribu- tion, the rights of public performance and display, and the right to prepare derivative works.") (footnote omitted); Peter H. Karlen, Appraiser'sResponsibility for DeterminingFair Mar- ket Value: A Question of Economics, Aesthetics and Ethics, 13 COLUM.-VLAJ.L. & ARTS 185, 210 n.157 (1989). 6. It may not always be in the best interests of estate beneficiaries that the value of property for estate tax purposes be reduced by all available discounts. Under I.R.C. § 1014(a) (1) (1986), the basis of property acquired from a decedent is its fair market value at the date of the decedent's death or, if alternate or special use value is elected, its value under § 2032 or 2032A. A discount