Every day, there seems to be a new trend in investing, whether it’s new cryptocurrency coins such as Ethereum or investments in high-profile large-cap tech stocks, such as Nvidia. With the volatility of the stock market, investors are looking for innovative ways to safeguard their wealth, and they’re looking at the art market to do so. The United States is the largest art market, accounting for 42% of global art sales. A survey found that although emotional value remains the key motivation, 41% of collectors surveyed said financial value was now the primary motivation for buying art.
Three Features
Three financial features of the art market intrigue investors: (1) value retention, (2) portfolio diversification, and (3) return potential. Art holds its value over time and can be used as a hedge during periods of high inflation and intense market fluctuations. The valuation of art is independent of many external events and tends to gradually increase in value over time. Art also provides for portfolio diversification, which helps minimize risk. Many investors are intrigued by the potential for high returns on art investments. A study concluded that between 1995 and 2023, art investments produced an average 11.5% return on investment year over year, while during the same 28 years, the annual rate of return for the S&P 500 was only 9.6%.
Estate Planning Strategies
With art as a growing investment category, there’s an increased need for estate planning strategies designed for such investments. Investors may want to consider the following strategies to hold their art investments.
Irrevocable trusts. Irrevocable trusts can be an effective vehicle to hold an investor’s art investments, as they allow creative provisions that achieve the investor’s estate tax and financial goals. For example, an investor might add a leaseback provision to the trust so that even though the investor has made an irrevocable gift of the art to the irrevocable trust, the trustee can lease back the art to the investor. In exchange for leasing the art, the investor would make fair market value lease payments to the trust, which could be added to the trust corpus or distributed to the trust beneficiaries, as determined by the trustee and/or the trust instrument. Alternatively, an investor might consider creating an irrevocable charitable split-interest trust with the art (or its sale proceeds) passing to one or more qualified charitable organization(s) on the termination of the trust. This would allow the investor’s estate to receive a charitable deduction based on the fair market value of the transferred art.
Family entity. An investor could also consider creating a family entity, such as a family limited liability company or a family limited partnership, and funding such entity with a portion of the investor’s art collection. The investor (and their family, if desired) would receive membership interests in the entity, allowing for centralized management and ownership. Also, if structured properly (that is, creation of the entity for a business purpose), the investor could pass ownership interest to family members at a discounted rate, providing for additional tax savings in addition to the reduction of estate tax upon the investor’s death.
Art funds. These allow investors to pool their money and hire professional art investment management companies to adequately manage their art collections. However, high expenses, such as management, performance and maintenance fees and high minimum investments scare some investors away. Ownership in such funds could be held in trusts that place investors’ ownership interests outside of their taxable estates.
Freeports. Investors could consider shipping and storing art at freeports (storage facilities at specific shipping ports), resulting in art remaining outside of any country’s tax jurisdiction, meaning the investor would avoid taxes associated with the art, such as capital gains, sales tax or import duties.
Section 1031 exchanges. A tool investors could use in conjunction with the above vehicles are Internal Revenue Code Section 1031 exchanges, which involve the swapping of art pieces, allowing investors to modify their art portfolio as the value increases without recognizing any gains on the sale of the replaced art as long as it’s replaced with like-kind artworks.
The Long Game
Investing in art has its benefits, but it’s not without limitations. Entrance to the art market is pricey and comes with a steep learning curve. It’s generally illiquid, and, in most cases, to see real returns, investors must play the long game. However, because art appreciates over time and is insulated from much of the market volatility, it can be an ideal asset to accomplish investment and estate planning goals.
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