Borrowing against art is an option for creating liquidity for cash-strapped clients, but there are drawbacks, including borrowing costs, appraisal fees and a risk of losing the piece if the loan isn't repaid.
There are tax advantages of lending against art rather than selling it. Selling would create income, while lending doesn't because the loan against the asset will be repaid.
While art lending tends to be more expensive than other specialty lending, it could be a possibility if it is one of the few available options for a client who needs to offer collateral.
"If it's a true loan that's securitized by the artwork, that's not income because they have an obligation to repay," said Duncan Campbell, Frisco, Texas-based principal and individual tax leader at Baker Tilly. "The only time it's income is whenever the obligation to repay is no longer there, and they're still in possession of the cash."
Banks will probably loan 40% to 60% of the appraised value of the artwork, and if there is a failure to repay, the bank will take possession of it, similar to real estate collateral, he added.
"You don't have income until you've risen to a higher standard of wealth from [the] previous statement, so if you still have an obligation to repay, even though you have possession of cash, you've not increased your wealth," Campbell said.
Collectors borrowing against their art, as opposed to selling, can maintain ownership of it, giving them flexibility and choice.
"Art lending can create liquidity without selling the artwork and triggering capital gains," Joon Um, Beverly Hills, California-based tax advisor at Secure Tax & Accounting, wrote in an email to Financial Planning. "It may work for clients with valuable art, strong cash flow, and a clear repayment plan. Watch for high interest, appraisal fees, low loan values, and the risk of losing the art. The loan itself does not automatically create a tax deduction."
Another potential usage for art lending comes with trusts when heirs are split on preserving collections versus receiving distributions, Founder and CEO Rebecca Fine of Athena Art Finance, a special finance company, recently
Is it the best or only way to get liquidity?
Art lending is one of the ways to get liquidity from debt or leverage. But using art as collateral has drawbacks compared with other methods.
"It's last on our list in terms of a strategy that would be feasible for a client, and the reason for that is art lending is very expensive in terms of specialty lending practices," said Wesley Karger, co-founder and managing partner at Boston-based registered investment advisor TwinFocus. "Art is typically a much smaller portion of our client balance sheets, and whenever we go to a specialty lender … they charge much higher rates than would otherwise be available if you were to go mortgage your home or use a securities-based line of credit."
For example, an elderly person with an upside balance sheet, no liquidity and a large collection of art could potentially borrow against it and avoid triggering capital gains, Karger said.
When balance sheets are more complex, he might look to an art lender, but generally, a securities-based line of credit would be better, he said. They can borrow at a lower interest rate, 50 basis points more than the secured overnight financing rate (SOFR). However, art lenders tend to charge 6% to 10%.
Every quarter, Campbell goes through the maturation of a client's art against his line of credit to make sure there is enough collateral, he added. If there isn't enough collateral in this type of situation, a client might have to pay off debt early.
"I wouldn't say it's necessarily something that's specifically recommended," Campbell said. "It's just another tool in the ultrahigh net worth individual's toolbox for their assets that they've acquired over time to be able to access liquidity."
