Comparing Fair Market and Insurance Valuation for Fine Art
When it is time to put a value on artwork, hiring an appraiser is likely first on a collector’s mind. An art appraiser’s expert opinion (and extensive training) provides peace of mind that a collector understands what the artwork is worth, and how to approach selling, gifting, or insuring a collection. However, there is more to valuation than a simple appraisal, and various approaches to the process. Here, we will investigate some of the aspects of valuing art and recognizing what types of valuation that may be needed in various situations.
When a Valuation May be Necessary
For most of the time that a collector owns artwork, simple enjoyment is in order. However, there are times when a valuation is needed, like:
- Taxable estates
- Gifts subject to transfer tax
- When claimed as an income tax deduction
- Theft or damage
- Equitable division in a divorce or legal settlement
When involved in one of these scenarios, collectors need to know what their art is worth at a specific time. However, each of these situations may require a slightly different approach to the valuation process.
Types of Art Valuation
There are three types of art valuation:
- Auction Value
- Fair Market Value (aka Retail Value)
- Insurance Value
When determining the auction value of a work of art (and often, any type of collectible), this value is given based on what the item would sell for at an auction, where no buyers or sellers are forced to enter into a transaction. For ordinary works of art, this value can be low, as there is no pressure on potential buyers, and due to the small time frame that a work is available, there are limited buyers and lower demand. However, in some instances when buyers have come to an auction looking for a specific work of art, and knowing that it is uncommon, a bidding competition can ensue, raising the price considerably. Due to this situation, an auction is considered an ideal place to reach the maximum value for a scarce or uncommon piece of art.
Fair Market or “Retail” Value
Fair market value, in basic terms, is the price an object would bring to the seller when sold on the open market. The American Society of Appraisers defines fair market value as “An opinion expressed in terms of money, 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 relevant facts, as of a specific date.”
The fair market or retail value is based on what an item would bring in a retail store, to the average buyer. This value is most often higher than the auction value, because the market is larger. An art dealer selling works displayed in a gallery has a much longer time frame to showcase a work of art, and with traffic in and out of a store (or visit to an online site), there are many opportunities for a buyer to discover and purchase a piece of art, providing a higher chance that the “retail” (aka, higher) price will be paid.
Insurance (aka Replacement) Value
For many people, this is a common term which describes any type of valuable (real estate, house, automobile). This describes the amount needed to replace the item when there has been a loss and the owner is forced to buy the replacement from a retail location. The IRS further clarifies this term by including the definition of “reasonable time,” and not to force the owner to search for a “deal” for several months. This price not only represents the sales price of the work, but is defined to include sales and import taxes, as well as any commissions or premiums incurred in the purchase, since the art may have been found overseas, and with a curator or advisor assisting the collector.
Four Types of Replacement Value
Due to the complicated process involved in replacing some works of art, the term Replacement has been further broken down into four designations:
- New Replacement Value: When an item is available to be purchased new;
- Second-hand Replacement Value: This reflects the cost to replace the work with something similar in comparable condition;
- Facsimile Replacement Value: This represents the cost of recreating the original in a general likeness, using the same materials;
- Liquidation Replacement Value: This value is based on the premise that the item was sold under duress or other limiting conditions which could have adversely affected its sales price.
IRS “Statement of Value”
When valuable art is changing hands, tax decisions will likely be involved. The IRS “Statement of Value” requires more than an educated guess for anything over $5,000, so an appraisal is necessary. Any taxable transfers of collectible items over that price point must be included in tax returns. However, an appraisal is usually valid for several years, depending on the volatility of the market, so it is not something that must be undertaken often.
There are three approaches to valuation, each with their own specifications:
- Income Approach: This is used to give value to an item which may be used to provide income during ownership, even if far in the future. This is often used for organizations which rent art for display.
- Cost Approach: This type of valuation is founded on the premise of an identical piece being created. Because of the disparity of time and materials involved in fine art when compared to its value, this is not used often.
- Comparative Market Data Approach: This kind of valuation is often used with private collections. This method attempts to determine the cost incurred when purchasing a piece of art by the same artist or one of similar quality, and a piece created in the same genre, content, and material. By using a variety of comparable (like valuating homes in a neighborhood), common art markets are scoured to determine a value.
Art Valuation Professionals
To ensure that uniformity is established in art valuation, there are standards which appraisers must follow. The USPAP (Uniform Standards of Professional Appraisal Practice) governs not only fine art and collectibles, by real property, intangible assets and business valuations. Created and maintained by the Appraisal Foundation (AF), this provides Congressionally-authorized standards to protect consumers and markets. There are three main appraisal organizations where art appraisers can achieve certification, and two which are specific to art and membership is offered by invitation only:
- American Society of Appraisers
- Appraisers Society of America
- International Society of Appraisers
- Art Dealers Association of America (ADAA)
- Private Art Dealers Association (PADA)
Understanding Valuation is a Key Part of Art Collecting
By understanding the types and methods of art valuation, collectors can determine how to approach ownership. This knowledge provides confidence in buying and selling art, attending unique venues like art auctions and fairs, allows owners to make informed decisions regarding insurance, estate planning and gifting. We at Sybaris Collection have a network of certified appraisers to help you establish a strong and protected art collection.