Art collectors can use fractional-interest ownership to reduce the value of their estate to save on federal estate taxes. In Elkins v. Commissioner of Internal Revenue, 767 F.3d 443 (5th Cir. Sept. 15, 2014), a case that originated in U.S. Tax Court, the U.S. Court of Appeals for the Fifth Circuit ruled that the value of an estate can be significantly lowered by allowing a discount on the value of fractional-ownership interests in artwork. By setting up an ownership structure where several people own varying ownership interests in one piece of art, savvy collectors can avoid paying large estate tax fees.

In Elkins, two daughters who were the executors of their father's estate filed suit in Tax Court over a dispute they had with the IRS. The primary disagreement between the IRS commissioner and the estate was whether the estate could apply fractional-ownership interest discounts when determining the taxable value of the estate's share of the artwork. To put it simply, fractional ownership, typically used in real estate holdings, is a situation where two or more people own a part of an undivided piece of property. In putting a value on a fractional-ownership interest for estate tax purposes, the IRS typically applies a discount to those interests because, unlike something that is owned outright, a fractional-ownership interest is typically less marketable and, therefore, less valuable. Further, an owner of a fractional interest in property typically has less control over the property than someone who owns it outright.

In Elkins, the commissioner of the IRS argued in Tax Court that when valuing the estate, no fractional-ownership interest discount should be applied to the decedent's shares of the artwork. The estate, conversely, produced a substantial amount of evidence, including three experts, all of which weighed in favor of applying a fractional-ownership discount of 44.75 percent to the decedent's interest in the artwork. The Tax Court rejected the commissioner's “no discount” argument and accepted that a fractional-ownership interest discount should be applied to the artwork. The discount the Tax Court applied, however, was a “nominal” 10 percent. On appeal, the Fifth Circuit agreed with the Tax Court that a discount should be applied for a fractional-ownership interest in art, but noted that the 10 percent number at which the Tax Court arrived was essentially arbitrary. According to the Fifth Circuit's opinion, “there is no viable factual or legal support for the court's own nominal 10 percent discount.” Assessing the evidence presented to the court and ruling in favor of the estate, the Fifth Circuit held, among other things, that the 44.75 percent discount for which the estate argued was valid, largely because the commissioner failed to properly introduce any evidence supporting the commissioner's view of the “proper” discount. At the appeal level, the commissioner tried to raise an argument for the application of the Tax Court's 10 percent discount, but the Fifth Circuit properly held that it could not rule on an issue that was raised for the first time on appeal. Accordingly, the court found in favor of the estate and applied the estate-backed 44.75 percent discount.