Through a long, hot summer, jittery investors fretted about the fragile economic recovery. Meanwhile, the other economy-the one filled with luxury goods like fine wines-sailed serenely along. The Liv-ex 100 Fine Wine Index, a leading industry benchmark of the most highly prized tipples-mostly French-was up 26.8% for the year through Aug. 31 and 33.4% over the past 12 months.

For wealthy clients with substantial wine cellars, that's a big boost to their net worth. Regardless of whether they are legitimate investors or merely collectors-a distinction the IRS will be sure to make for you-investing in wine can deliver serious value to your clients.

SPECIAL HANDLING

Wine like other luxury goods, requires special treatment by advisors. Estate attorney Matthew Erskine, a partner in Erskine & Erskine in Worcester, Mass., says most advisors and clients tend to treat large stores of wine wealth as "an afterthought" in financial and estate plans. Erskine, who specializes in tangible personal property, including such illiquid and tricky-to-value items as wine, art, classic cars and antiques, has seen that mistake result in big tax consequences time and time again.

Accounting for a serious wine collection when doing financial and estate planning requires some thought. It does not mean simply tacking it on to the end of the wealth statement or lumping it with other tangible personal property that does not appreciate in value, like non-antique furniture or cars.

It means planning for it just like for a portfolio of stocks. The cellar should have a complete inventory, and the valuation should be updated at least once a year, estate attorneys say. It should be insured, and there should be a plan for disposing of it after the client dies-assuming the heirs don't opt simply to drink it.

How does an advisor make sure all of this is properly done? You don't have to be an oenophile. You just need to have a good crew with the right expertise.

This group should include a wine investment expert. These professionals are much like the freelance curators who manage the art collections of wealthy investors. "The market is too fragmented and inefficient to go in without help," Erskine says.

Financially managing a wine cellar also calls for an estate attorney knowledgeable in tangible personal property law. An accountant with specialized knowledge is nice, but not necessary.

COLLECTOR OR INVESTOR?

With the crew assembled, the first thing an advisor needs to know is whether the IRS characterizes the client as a collector or an investor. Everyone who has a wine cellar is, by definition, a collector. Investor may sound pedestrian, but it's a more desirable designation; investors pay much lower taxes.

If collectors do sell anything out of their cellars, they will pay a 28% capital gains tax rate, because the wine will be considered a personal asset. And they can't take any deductions for the expensive measures they take to maintain their cellars.

Investors, on the other hand, will pay a 15% long-term capital gains tax for commercial property, because their cellars are considered business inventory. (Unless Congress takes action, that rate will eventually climb back to 20%.) Investors can also offset gains on wine purchases with losses from other wine purchases. Collectors cannot.

Estate attorney Mike Whitty at Vedder Price in Chicago cautions, though, that "most casual hobbyists" won't rise to the level of investor. "You can't just buy it and say, 'I'm holding the stuff for an investment,'" Erskine says. He notes that most collectors buy and buy, and only occasionally let the odd bottle go.

There are several ways to prove investor status, and shrewd clients will use most if not all of them. Meticulous recordkeeping is necessary to establish a pattern that a client is buying and selling wine to make a profit.

One key is having a tracking system of some sort-usually a spreadsheet detailing at what prices clients bought and sold the wine. Keeping receipts is also wise. Clients must show they are realizing a return on their investment.

Further, they must show that they have a procedure for selling the wine. An example might be selling when a bottle has met two times cost basis. "Just like an investment policy for a portfolio, you need an investment policy for your wine collection," Erskine says.

MAKING A PLAN

The wine expert can help clients set up the investment policy. For example, the management plan might concentrate only on certain vineyards, only on Bordeaux or only on Burgundy from a certain region, say, if clients want to have a strong position in a certain market. Other parameters might be buying wines only under a certain cost, say $35 per bottle-analogous to buying only stocks under a certain P/E ratio.