digital art investment trusts and willsons estate

zone71976 April 19, 2023 Comment

This is Toni Ann Kruse, ACTEC Fellow from New York City. What are non-fungible tokens, NFTs, and what do you need to know to address them in your practice? ACTEC Fellow Professor Gerry Beyer of Lubbock, Texas, will give us the details. Welcome, Gerry.

So, we start off, what is a non-fungible token, or NFT? Well, here we go. Here’s the definition. It is a unit of data stored on a blockchain that certifies that the digital asset is unique and not interchangeable. Oh, yeah, yeah, that really makes a lot of sense, right? So, let’s break it down.

We’ll start first with what do NFTs represent in the real world? Well, they can represent photos, videos, audios, artwork, gaming tokens, or any other type of digital file. Now, how does an NFT get created or as they say, minted, or born? Well, first they are created on a blockchain. Ethereum is the most popular one. Then we have the creator, who will often be an artist of some sort, and will link the NFT to a specific item of intellectual property that it represents, links it to the photo, the video, whatever.

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Now, the NFT does not contain the intellectual property, the photo or video, etc. It just refers to the intellectual property, and the creator promises that it is either unique or they’re only going to create 13 of them, and this is No. 7 of 13. And they probably will promise that they won’t create any more of them. And then, each NFT has a unique address and whomever has the address and access to it, owns the NFT. It’s also interesting to note that the NFT can also contain a smart contract, so that the creator can get a percentage when the NFT is later sold.

Now, I appreciate that this still may sound a little confusing, so let’s use an analogy. It is similar to an autograph or a baseball card or a coin or a stamp. They have no intrinsic value, right? A baseball card, you know, they don’t have any value except someone wants it. So, it all depends upon market forces, just like any other collectible item, baseball cards, coins, stamps, autographed items. So, the underlying item, though, the artwork, the song, will still be available and is not owned by the NFT owner unless the NFT owner also created the underlying property.

So, how about this example? Let’s assume that I have a 45 of Stairway to Heaven autographed by Page and Plant. And by the way, for those of you that may not know, a 45 is a small-sized vinyl record that used to be very popular back in the day. Well, this autographed 45 would be extremely valuable. It is unique. It would have value to a collector. But there are millions of copies of the intellectual property, that is of the song, Stairway to Heaven, out there in the world. But if I had that autographed physical 45 – I wish I really did – it would be really valuable, just like if you had a unique or limited issue NFT.

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Now, why are people creating them? Well, it is a way of getting electronic files that have the same type of transferability and scarcity that the physical things like baseball cards have. So, NFTs provide value to collectors by giving them the ability to own unique works, just like physical art, rare baseball cards. There is value to collector in having one of a kind or limited issue items.

And all NFTs are doing is taking this concept of uniqueness and applying it to digital works. And it gives them an effective method of selling, monetizing their digital works. And the scarcity that is created through the NFT makes the digital work more valuable, which then will lead to more profit for the people who create it or the people who buy and sell it.

So, let’s start now by looking at some examples. The most valuable NFT ever was just sold by the auction house, Christie’s, on March 11th of 2021, and it was called EveryDays: the First 5000 Days by Beeple. It is a collage of 5, 000 individual pieces that were created daily for over 13 years. And I hope you’re sitting down for this, because this NFT sold for over $69 million.

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Now, there are other examples that aren’t nearly as expensive. For example, gaming tokens that are used in various online games. One of the ones that are very popular is called CryptoKitties. It’s an online trading card game that allows users to buy, sell, and breed unique NFT kittens. There was one recently called Dragon, that was sold for $172, 000. But this is a game that kids and people play. So, the prices aren’t always high. The average price back in 2018 for a CrypoKitty was $60, with the median price just being $9. So, they can be bought and sold very economically.

In addition to NFTs being used for gaming items, the sports industry is also getting into the selling of NFTS, which makes sense because they already are familiar with selling baseball cards and other tradeable items. So, the NBA has actually set up a digital trading card platform, which is called Top Shot, and they recently sold an NFT entitled LeBron James, Dunk From the Top for $210, 000.

And then, on July 4th of 2021, Lou Gehrig’s Luckiest Man speech is going to be auctioned off with all proceeds from the sale going to the support of ALS charities. Now, what are some potential future uses for NFTs in addition to these types of collectible items? Well, one possibility is for the authentication of physical assets. And in fact, Nike is already working on this with their CryptoKicks program.

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What they’re envisioning is a system whereby a shoe would be assigned a unique token by Nike, which could then be used to verify the shoe’s authenticity. And then, subsequent purchasers who buy and sell high-end sneakers would have greater confidence in the authenticity of their purchase, not that it is a knockoff. There has also been speculation that NFTs could operate as a highly secure method of transferring title to real property, of storing wills and other estate planning documents, and so on.

Now, with all of that in mind, let’s take a look at some estate planning advice. Well, to start with, ask your client if your client owns or intends to purchase NFTs. So, this should be a question included in your standard client questionnaire because recognize that the client’s ownership of just one NFT could actually equal a taxable estate in some circumstances.

And then, be sure your client carefully tracks the price paid and the amount received when it’s sold because these types of things will accrue capital gains and capital losses, and that needs to be properly computed so the correct taxes can be paid.

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Now, what about using NFTs as a trust investment? Well, think about the prudent investor standard. Investment decisions must be made in the context of the trust portfolio as a whole and as part of an overall investment strategy having risk and return objectives reasonably suited to the trust. Well, NFTs, I think, are way too risky. Their value is extremely volatile. Remember, you can kind of look at this as an analogy to cryptocurrency. And look at the huge price swings in Bitcoin and other cryptocurrencies.

So, a trustee should be extremely hesitant to invest in NFTs unless they have express permission from the settlor, a release by the beneficiaries, or an authorization in a court order.

Before we finish, a few warnings are important. If your client has an NFT, they must protect and be sure to transfer the private key and any other information needed to access the NFTs. You have to be sure someone knows the client owns an NFT and that they can have access to the private keys and passwords to access the digital wallets where these things are stored. Otherwise, without that access information, an NFT, just like cryptocurrency, could be lost forever.

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I hope our discussion today has kind of made you understand what NFTs are: what they are, how they impact estate planning, and why you need to keep them in mind when you’re dealing with your estate planning clients.

Wonderful. Thank you so much, Gerry, for your insights on estate planning with non-fungible tokens, such a hot topic and really glad to hear more about it

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