The Global Art Market, Collectors as Investors and The Approach to Fine Art

First Republic Investment Management
March 13, 2014

Record prices for fine paintings, sculpture and jewelry have focused considerable attention on the art market of late. Among the blockbuster acquisitions of 2013 was Francis Bacon’s 1969 “Three Studies of Lucian Freud” triptych, which sold for $142.4 million at Christie’s in New York, the most expensive work of art ever sold at auction. Other notable pieces sold last year included Alberto Giacometti’s 1955 “Grande tete de Diego,” a $50 million sale at Sotheby’s, and Isaac Wolf’s $83.2 million purchase of a 59.6-carat diamond known as the “Pink Star,” sold by Sotheby’s in Geneva.

Collectors spend a considerable amount of effort and money assembling a personal collection that may appreciate dramatically over time. Valuations, provenance, financial planning and records management are critical.

Contemporary and postwar works are the priciest segments, fueled in part by younger wealth in the United States and new buyers from emerging markets across the globe. Much has been written about potential “bubbles” in the art market as well as the commercialization of many aspects of the art form. There are now numerous benchmarks and indices designed to analyze publicly available sales data, trends and predictive values. Interestingly, the Mei Moses World All Art Index, the industry’s most widely cited benchmark, reports the market for fine art actually declined 3.3% in 2012 yet gained 2.2% through early November 2013. (By comparison, the Standard & Poor’s 500-stock index gained 13.4% in 2012 and had increased more than 27% through late 2013.)

For many investors, these prices are viewed with skepticism. Art is largely considered an unregulated market. A degree of transparency exists in art auctions, but less so in gallery or dealer pricing and with private sales given free market dynamics. Ultimately, a buyer’s motivation may not be driven solely by monetary reasons, and art (as the ancient Greeks said), is in the eye of the beholder. Fine paintings, sculpture, antiques and jewelry, as art, possess intrinsic value, aesthetic value and, ideally for an investor, financial value.

Collectors spend a considerable amount of effort and money assembling a personal collection that may appreciate dramatically over time. The collection’s market value might constitute a significant measure of its overall net worth. And while it might be more exciting to focus on the act of collecting, a prudent investor is wise to approach the management of the collection with the same enthusiasm. Art, as an asset class, is unique with respect to estate and tax planning. It presents different implications with respect to valuation, risk management and disposition.

There are a number of financial and estate planning options available to collectors. Gifting is one popular technique. Giving to non-charitable beneficiaries (family, friends or heirs) may be accomplished during a collector’s life through gifts or upon death through an estate plan. As with other asset classes, gifts are subject to IRS limitations (annual exclusion of $14,000 per recipient and lifetime exemption of $5.34 million in 2014). Spouses may be eligible to combine the annual exclusion.

Non-testamentary gifts allow collectors to transfer ownership of a collection to a family limited partnership or limited liability corporation. A transfer of this nature provides the recipient with shares, or an interest, in the entity rather than in a specific work of art. This facilitates buying and selling of interests in the collection versus individual pieces of art, which might present conflict.

Giving to a charitable beneficiary such as a museum affords tax advantages and is attractive given many collectors’ emotional attachment to their art. IRS rules can provide a significant income tax deduction and favorable estate deduction to a donor. As with non-charitable beneficiaries, charitable gifts may be made during life or upon death. Lastly, one may opt to sell a collection, in part or in its entirety. In addition to potential commissions, an owner will owe the IRS 28% on the art’s appreciation. Net proceeds from the sale are then part of the owner’s taxable estate, and may also be subject to state and local taxes. Strict IRS rules and limitations apply. Valuations, provenance, financial planning and records management are critical.

For many collectors, art is a passionate purchase that can provide simple enjoyment as an aesthetic pleasure and an expression of taste. Yet there is ample opportunity for stewardship of an art collection. With advance planning, it also can offer a positive yield as an alternative investment.

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