<aside> 💡 Key Takeaways:

1. Art investments are illiquid and have multiple financial benefits.
2. Investors use trust funds to maximize tax benefits on artworks. The artworks in the trust are taxed annually at a lower rate than a tax on an outright artwork sale.
3. Real-world asset (RWA) tokenization adds an extra layer of liquidity to art investments. Investors benefit from holding fractionalized shares of the artwork in the trust while holding onto it.
4. More investors can participate in art investments through fractionalized shares of artworks, making them more accessible globally.

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1974, two years post World War II. Countries in shambles struggled to rebuild economies. The British Rail Pension Fund (BRPF), a retirement fund home to hundreds of thousands of Britain's railway labour force, chose to invest in art while in search of strategic, profitable investments. They devoted $70 million—about 3% of its holdings—to an art investment portfolio of 2,400 pieces.

1996. The fund sold 25 art pieces at Sotheby's for $65.6 million. They held the rest of the portfolio for two decades, selling the pieces over the years till the last one in 2003. Experts determine the fund generated an annual return of 11.3% - 14.1% (after accounting for inflation) for investors.

The BRPF was the first institutional and large-scale attempt at art as an investment, consolidating it as a legitimate asset class for investments. The art market experienced rapid growth shortly after, and more organizations turned to art as an investment scheme.

The Artist, The Dealer and The Investor

An art market consists of three parties: the artist, the dealer and the investor. The artist creates the artwork and decides whether to make it for a business or as a hobby. If an artist chooses the business route, they may use a dealer to process the transaction.

A dealer buys and sells art as a business, e.g. Sotheby's and Opensea. Artworks are sold many times throughout its life, and dealers earn a commission on each sale they make. The BRPF, for example, sold all pieces from their portfolio through Sotheby's. While we don't know the exact figure, they made a tidy sum from the sales.

An investor buys artworks to sell for financial gain. Investors aren't the only buyers—there are also collectors—but we shall focus on them for this article. Alongside financial gain, art investors benefit from deductions on taxes, income, gifts and, in some cases, estates.

In Australia, for instance, small businesses can deduct 100% tax on artworks purchased for the business under the Temporary Full Expensing rules. For investors who plan to sell their artwork(s), the IRS taxes 28% on long-term capital gains from each sale. To protect investments, minimize losses and maximize investment benefits, many investors use trusts, mainly charitable lead trusts (CLT).

Charitable Lead Trusts for Art Investments

At its foundation, a charitable lead trust (CLT) pays an annual lump sum to its beneficiary. The art investor, called a donor, creates the trust, funds it with assets (art, in this case) and sets the fixed number of years the trust should operate. Every year, payments from the trust are made to a beneficiary, either as a fixed payment or a percentage of the trust's asset—depending on how the trust is structured. At the end of the term, the balance in the trust reverts to the donor.

Here's an example

Justin bought an artwork as an investment. Following his tax attorney's recommendation, he funds a charitable lead annuity trust with his artwork valued at $200,000. His trust pays $10,000 (5% of the initial fair market value) to his son, the beneficiary, each year for 10 years, amounting to $100,000. Justin also receives an income tax charitable deduction of $89,825.85. After 10 years, the balance in the trust reverts to Justin. Assuming the trust earns an average 8% annual rate of return, he receives approximately $275,330.12 at the end of the trust term.

Trusts need funding to generate annual returns. Tax attorneys recommend liquid assets to fund a charitable lead trust, as illiquid assets like artwork make the process challenging. Investors might sell their artwork to fund the trust, but what if our friend Justin loves his artwork and doesn't want to sell? There is the option of tokenizing the artwork, where you get the crypto token equivalent of your artwork on the blockchain. This is where real-world asset tokenization comes in.