A recent Fifth Circuit Court of Appeals ruling has potentially profound implications for how the IRS values and applies the estate tax when the estate owns only a fractional interest in a piece of art.

Art collections have been known to cause extreme estate tax headaches. These collections can be very valuable and subject an estate to large tax bills. Because art is not a liquid asset, paying the estate tax requires either finding the money elsewhere in the estate or selling the art itself.

To complicate matters, valuable pieces of art that have been passed down for generations are often owned by multiple family members, with each owning a fractional interest in the art. This makes it even more difficult to handle estate tax issues.

If an estate owns only 10% of a piece of art, it can be difficult to find a buyer for the estate's ownership interest because potential buyers will rightly be concerned about having a say in how the piece will be handled.

Despite the difficulty of finding a buyer willing to pay full price for only a fractional ownership stake in artwork, the IRS has traditionally refused to give valuation discounts for estate tax purposes for fractional art ownership.

However, as reported by Artnet News in "Art Law on Estate Tax on Inherited Collection," the Tax Court and the Fifth Circuit Court of Appeals have overruled the IRS' position and ruled that a valuation discount is appropriate. The exact amount of that discount is currently not known, but it seems likely that new rules and regulations will need to be drafted and litigated.

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Reference: Artnet News (August 22, 2015) "Art Law on Estate Tax on Inherited Collection"