Art collectors are often unsure about the difference between appraisals for insurance, estate planning (fair market value) and sale.
The topic often comes up when clients are looking to sell their art, particularly at auction. Often the sales estimates obtained for this purpose are substantially lower than the values on the collector’s insurance schedule. Leaving aside for now the discussion about potential conflicts of interest (i.e. who does the appraisal and for what purpose) let’s look at these different values more closely.
Fair Market Value
Fair market value (FMV) is relevant for estate planning. According to the IRS, fair market value is defined as “the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”
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In a nutshell, the IRS considers selling art at public auction, which could be thought of as wholesale, closest to this scenario—as opposed to buying retail; i.e. at a gallery. For this reason, auction comparables (including buyer’s premium) are generally viewed as an acceptable approximation of FMV.
In the course of consigning art to an auction house, the client receives sales estimates that provide an indication of what price the auction house’s experts believe the property will fetch. That said, sales estimates have an added dimension: they are also marketing tools. Estimates that are too aggressive (i.e. too high) can deter potential bidders during an auction. This may result in the work not achieving the highest price possible or the work not selling at all.
Therefore, counter-intuitively, in certain cases it can be helpful to work with sales estimates that are lower rather than higher, provided the consignor understands that this means they run the risk of having to sell at a lower price.
The insurance value of an artwork has little to do with FMV or auction estimates. The insurance value of an artwork tends to be based on the full retail replacement value of that artwork plus extra costs that are incurred when replacing the artwork with a similar object. It is the amount of money that the insurance company has to pay out when a work gets damaged or lost. This means that when a collector obtains estimates for sale, although disappointing, it is normal for such estimates to be much lower than the values on the collector’s insurance schedule.