Money Report

An alternative asset class.

Has the economic crunch affected the international art market? Not according to Christie’s and Sotheby’s auction houses in New York, who rang up sales of $583.5 million in contemporary, modern and impressionist paintings and sculpture over two evenings in May of this year. The fine art market doesn’t always correlate with traditional financial investment markets but can offer an intriguing alternative asset class, particularly for investors concerned with accumulating capital gains rather than current income. There are certainly risks and considerations unique to art and there are very few art investors who buy for investment consideration alone. Considering the uncertainty of traditional financial markets, though, many investors with liquid capital look to fine art as a safe haven.

Frenetic media coverage of the art market and soaring prices have catapulted interest in art investing. The Mei Moses Annual All Art Index tracks repeat global auction sales of the same works and posted an 18 percent return in 2007, trouncing the S&P 500 stock index by about 14.5 percent. Established 130 years ago, the index tracks the historical performance of art as an investment and asset class.

In 2007, British money-management firm Artistic Investment Advisors launched the Art Trading Fund, the first hedge fund to trade art as a commodity, offering a hedge strategy as well. The long-term objective of the fund is to create an art market index much like the S&P 500, in which investors can participate, but art funds have their skeptics and supporters and many question whether fine art can be reduced to a tradable commodity.

Fine art markets, though, are not immune to the same valuation bubbles that occur with financial and real estate assets, particularly in contemporary art where prices can be driven by taste and fashion. The last art market bubble, caused by soaring Japanese demand for Impressionist paintings, occurred in the late 80s and early 90s. Recent record setting art auctions were driven to some extent by newly affluent Russian and Indian buyers competing with traditional western collectors for top works, fueling the market, and creating record prices.

New or seasoned, most collectors want to share their acquisitions (notably, their collecting expertise and foresight) with others during their lifetime, and donating or selling art can provide a significant tax benefit. Knowledge of the various distribution strategies and selection of the appropriate donor vehicle is important, as well as consultation with your financial and tax advisors. These are some of the most commonly used art-donating vehicles.

A charitable remainder trust is an effective solution for collectors seeking to convert some of their collection to income and minimize taxes, which are assessed on art profits at the high short-term capital gains rate. The collector sets up the trust and donates artwork to it. The art is sold and the trust invests the proceeds. The trust is a tax-exempt entity so the donor avoids capital gains taxes and may be able to take a charitable deduction. For a specified period (usually until the donor’s death), the trust uses investment proceeds to make annual payments to the donor or other beneficiaries. Upon death, the trust’s balance goes to the designated charity.

A donor-advised fund is another option for individuals and families wishing to manage charitable giving. Donors give artwork to the charity of choice, the charity sells the works and proceeds are used to establish the donor-advised fund. Donors determine how proceeds are dispersed and, since the fund is tax-exempt, avoid paying capital-gain taxes. One drawback, however, to the donor-advised fund: donors are only able to deduct what they paid for the work, rather than the current fair-market value.

Collectors selling artwork in boom markets stand to make huge profits but are hit with up to 28 percent capital-gain taxes. However, by gifting a painting to a museum, donors are eligible to deduct the current fair-market value, since the receiving party (museum) is using the artwork for the museum’s tax-exempt purpose.

Until recently, fractional gifting was one way collectors could share their collections with museums. It was advantageous for collectors to gift in fractions to a museum over several years; terms are negotiated between collector and museum. When the artwork was not in the museum it was kept in the collector’s home. The donor would reap increasing tax deductions for each fraction donated as the artwork appreciated, until the entire interest in the work was given away to the museum. However, the Pension Protection Act of 2006 included a provision severely limiting donors’ ability to gift over a period of years, capping deductions and creating adverse tax consequences.

In July 2008, the Senate Finance Committee agreed in principle to “loosen stringent limits… that made partial gifts less advantageous for donors.” Art collectors and institutions alike will follow this provision as it makes it way through the legislature.

Despite concerns of liquidity and irrational pricing, top-quality art remains a stable financial investment during turbulent times. Still, the subjective nature of what is considered art, or collectible and valuable art, dictates that financial gain should never be the sole reason for making the purchase. Discover your passion, develop a collectors eye and consult a reputable art advisor. Remember that while financial gain can be elusive, the art you own will pay dividends if it enhances your quality of life and that of future generations.

Gigi Harris and Steven Weber are investment advisors for the Bedminster Group, a fee-only advisor providing investment and financial counsel to clients in the Lowcountry since 1997. The information contained herein was obtained from sources considered reliable. Accuracy cannot be guaranteed. This is not a solicitation to buy or sell any securities. Furthermore, opinions expressed are solely those of the author and do not necessarily reflect those from any other source.