In this novel, the issue is not so much the inability to distinguish between art and reality as it is the conscious choice—and supernatural ability—to aestheticize reality and, in so doing, to sever the connection between morality and beauty. Ugliness has a deeply moral dimension in this story and is understood as both a consequence of and a check on immoral behavior. Once physical ugliness is removed as consequence, Dorian Gray is able to act unchecked on his impulses.
In this profoundly moral novel, Dorian Gray is tragically able to make a deal with the devil, in which he trades the aging of his beautiful body with the aging of a portrait of himself. He becomes, in physical form, the work of art that never ages or changes. The work of art, which he hides in the attic, becomes increasing older and corrupt instead, showing all of Dorian's moral degradation.
Dorian is, tragically, able to distinguish between art and reality. It is what he can't escape. He knows the picture is aging instead of him, and he understands the freedom to harm and destroy others that his unchanging beauty affords him. Dorian assumes that the increased ugliness that comes with his aging is due as much to or more to his sins—our moral errors—than to the natural processes of aging. Because he carries the stigmata, so to speak, of sin on a body, this eventually becomes a warning to others, signaling them to be repulsed by and to stay away from our physical and moral corruption. To the extent that there is confusion between art and reality, it is in the people who confused by Dorian's appearance.
The novel's main characters, especially Dorian and Henry, are obsessed with outward beauty or aestheticism. Dorian places an excessive importance of preserving his looks and surrounding himself with beautiful art. His mistake is in thinking that he can shellac over moral ugliness with these outward forms. This doesn't work, and Dorian's moral anguish and psychological misery at the empty life outward beauty causes him to lead brings him to increasingly loath both his life and his painting—the manifestation of his soul. He comes to hate his corrupt inner self to the point that he commits a form of "suicide" by stabbing his painting, an act which leads to his own death.