Damage is one thing, taxes are another

When it comes to insurance, most people look for ways to keep their premiums as low as possible. But the smart money looks to pay as little as possible for the best coverage they can find.

The best coverage is hardly the cheapest, but it often provides more protection. It could be more protection as in higher limits for losses or lower deductibles, replacement cost coverage versus depreciated value coverage or no excess liability coverage versus $5 million of coverage.

Beyond the basics of most homeowners and auto policies is where you would look to cover valuables such as jewelry, art or other collectibles like wine, signed memorabilia, stamps or baseball cards. Any collectible is subject to accidental damage or ruination from the elements.

Your typical homeowner’s policy often has very low limits for these collectibles and are not likely to compensate you for any significant appreciation that has occurred since you’ve acquired that item. If you own collectibles as a part of a trade or business activity, or even if it’s your “side job,” it will raise an entirely different set of insurance issues. In this case, it may be wise to consider a separate business policy covering your business activity and inventory. Talk to a qualified agent even if you hold certain pieces for years prior to sale.

Another issue taking a bite out of your collection: taxation. As you know, sales of collectibles that create a gain would require claiming that gain and paying taxes on the amount of the gain.

Remember to factor in the income tax potential from the sale if you are planning to use those funds for retirement or other needs.

For larger collectors, the death tax could cause a real problem if the intent is for the collectibles to be passed on to beneficiaries. These valuable but illiquid assets would be taxed on their fair market value on the date of death. As of now, the estate tax threshold is over $11 million federal and only $1 million in my home state of Massachusetts. That could put many collectors in a situation where state taxes would be due.

You can’t really protect against the income tax issue for gains, but for the estate taxes, you have options for mitigation, offset or avoidance.

For mitigation, you can begin to gift some of your collection to eager and interested beneficiaries during your lifetime. For offsetting the tax, you could buy a life insurance policy on your life in an irrevocable trust. This would create a tax free pool of funds to pay the death taxes due upon your passing. This is often used for larger estates, but is frequently ignored by collectors.

To avoid paying any income or estate taxes on your valuables, gift them to a charity now or upon your passing.

Collectibles are fun, valuable and can be profitable for those in the know. Make sure that you have the protection that you need.