If a piece of art worth $65 million cannot be legally possessed, sold or purchased, is it still worth $65 million? This was the dispute that played out between the I.R.S. and the beneficiaries of the estate of Ileana Sonnabend related to a piece of art by Robert Rauschenberg entitled “Canyon” held by the Estate.

Upon Ms. Sonnabend’s death in 2007, this deceased New York art dealer possessed an art collection worth roughly $1 billion, including paintings by Jasper Johns and Andy Warhol. The lawyer for the beneficiaries, Ralph Lerner, told the New York Times that the beneficiaries have already sold off a significant portion of the art collection to pay approximately $471 million in federal and state estate taxes.

But the beneficiaries drew their line in the sand when it came to valuing and paying tax on the sculpture combine entitled “Canyon“. You see, this particular piece of art was affixed to a stuffed bald eagle. However, in accordance with the 1940 Bald and Golden Eagle Protection Act and the 1918 Migratory Bird Treaty Act, it is illegal to possess, sell, purchase, barter, transport, import or export any bald eagle, either dead or alive. As set out in a notarized statement by the artist himself, this particular eagle had been killed and stuffed by one of Teddy Roosevelt’s Rough Riders prior to the 1940 law coming into effect. Nonetheless, possession of the Canyon remained contrary to the 1940 Act. It appears that Mrs. Sonnabend was allowed to keep the sculpture as a result of informal approval in 1981 from the United States Fish and Wildlife Service. In 1998, Mrs. Sonnabend’s ownership of the sculpture was allowed to continue so long as the sculpture was displayed at a public museum (resulting in the sculpture being on long-term loan to the Metropolitan Museum of Modern Art in New York).

Following her death, Mrs. Sonnabend’s beneficiaries reported that the Canyon sculpture had a value of $0. If the sculpture could not be legally bought or sold, they determined that the fair market value of the Canyon must be nil. However, the I.R.S. disagreed, attributing a value of $65 million to the Canyon, and sought approximately $29.2 million dollars in estate taxes, interest and penalties. As it turns out, the Art Advisory Panel, which advises the I.R.S.’s Art Appraisal Services unit, elected not to consider the restrictions on the sale of the Canyon and only considered its artistic value.

It is not unusual for the I.R.S. to attempt to tax transactions in contraband at their market value. Al Capone went to jail for not paying tax on his illegal income. But the circumstances related to the Canyon are somewhat different. The Canyon has not been sold. There is no black market transaction to tax. The I.R.S. was relying upon an assumption that the beneficiaries were willing to enter into an illegal transaction in order to determine its fair market value of $65 million.

In the end, the parties settled their dispute. The I.R.S. agreed to absolve the beneficiaries of any tax liability, if the Canyon was donated to any museum open to the public. On November 27, 2012, the director of the Museum of Modern Art in New York announced the receipt of the gift by the family of Mrs. Sonnabend.

But the settlement begs another question – if the beneficiaries placed the value of the Canyon at $0, can they still get the charitable tax deduction?

Have a great weekend.

Jonathon Kappy