There is a buzz about art as an investment asset class. Clients and their advisors are seriously considering making direct investments in artwork or indirect investments though art-specific investment funds. Art is indeed an asset class, but a recent estate audit I consulted on is an example of how treating art like any other alternative investment for discounting purposes can lead to trouble.
The client died in 2010 owning a multi-million dollar collection of artwork, among which were 48 items that are of the very highest quality and of the same type and genre. The quality of the artwork was so high, in fact, that only 17 pieces of artwork of similar genre and quality had sold in the prior 15 years. On the estate tax return, the estate took a 25% discount for lack of marketability, an average discount for most limited partnership interests in alternative investment assets. In 2014 the estate was audited and the examining agent asked the estate to justify the 25% discount; I was asked to give my opinion on the reasonableness and justification for the discount.
The discount is justified, not because of lack of marketability, but because of a lack of liquidity and as a block sale. The estate had the right to sell all of the artwork at auction as part of the settlement of the estate. They could have placed the entire collection at auction in a block, severely depressing the price of the artwork; or they could have placed the items on commission and sold, on average, about one a year at the full fair market value, which could be expected to take 48 years. (In fact, the estate did put the artwork on sale through a dealer, but has only sold one piece since 2011).
The amount of the discount is low. Based on the method used by the Tax Court in the Calder estate, which basically uses the IRS annuity table to calculate what the present value of the revenue stream would be if the collection were liquidated over 48 years, the discount for this lack of liquidity and likely block sale effect is 45.2%.
The lesson learned is: seek out expertise in planning for the ownership of artwork, even as an alternative investment, since the planning and techniques that are effective for other alternative investments will work when that investment is art.