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Gold is a hot investment again. There are a lot of ways to invest in gold, and there are different tax consequences for each of these methods. Gold investors aren’t going to have equal after-tax returns, and part of the reason is the differing tax treatments of the ways to invest in gold.
Consider the tax effects of different choices before deciding how you want to own gold.
Bullion. There are several ways to own gold bullion directly. You can buy gold bullion bars and store the bars yourself or have them stored at a facility. Bullion coins, such as Krugerrands or American Eagles, also are an option.
Bullion is a collectible under the tax code. That means it is ineligible for regular long-term capital gains treatment. Instead, gains on bullion held longer the one year are taxed at a maximum 28% tax rate. Gains on bullion held one year or less are taxed as ordinary income.
ETFs. Exchange-traded funds are an indirect and the most liquid way to own bullion. The two main ETFs that buy and store bullion are iShares Gold Trust (ticker: IAU) and SPDR Gold Trust (GLD). These funds actually are trusts with interests that trade on the stock exchanges.
You can buy and sell shares in an ETF on a stock exchange through a brokerage account. The ETFs charge annual expenses, and their returns are very close to the spot price of bullion minus the expenses.
A big advantage of the ETFs is liquidity. You can sell the shares any time the markets are open and as quickly as any stock can be sold. The ETFs generally trade at only modest premiums or discounts to net asset value.
Shares of the ETFs are considered investments in collectibles for purposes of the capital gains tax rules, according to Private Letter Rulings issued by the IRS. When the ETFs are held in a taxable account, sales of the shares held longer than one year are taxable at a maximum 28% rate instead of the standard long-term capital gains rate.
The Private Letter Rulings are 200732026 and 200732027. The rulings were issued to the exchange-traded funds and are referenced in the “Tax Risks” sections of their prospectuses.
There are other ETFs backed by gold bullion that might have different tax consequences. Sprott Physical Gold Trust (PHYS), for example, says that its structure allows investors to pay the lower long-term capital gains rates on sales of their interests.
Futures. You can trade gold futures yourself or own an ETF that does the trading, such as the PowerShares DB Gold Fund (DGL). This fund buys a number of gold futures contracts that should have essentially the same return as a gold index the fund attempts to track, though there are anomalies in the futures markets that can cause deviations.
The futures contracts aren’t considered direct ownership of gold, so they aren’t collectibles.
Futures are taxed very differently from other investments, and for tax purposes the futures ETF is taxed to the owner the same way individual futures positions would be.
In futures ownership and trading, all gains are 60% short-term and 40% long-term, regardless of the holding period. In addition, the futures contracts are marked to market at the end of each calendar year, and the paper gains and losses determined.
Investors must recognize on their income tax returns the net gains on the futures, whether or not the contracts are sold (or any distributions were made from the fund). With futures contracts, there is no deferral of taxes beyond the last day of the year.
A further aspect of this fund is that it is organized as a partnership for tax purposes. That means gains and losses pass through to shareholders’ tax returns each year. Net gains must be included in gross income, even if there weren’t any distributions and the investor didn’t sell the fund shares.
Exchange-traded notes. Exchange-traded notes (ETNs) are an alternative to ETFs. The investor in an ETN does not own the underlying asset. An ETN is a note, or debt, in which the note issuer owes the investor the initial investment plus or minus the return of an index, changes in the spot price of an asset, or some other named benchmark.
You can buy ETNs that promise to pay the return of the price of bullion, a particular gold index, or double or triple the return of bullion or an index. Some ETNs pay the inverse of the return.
The ETNs are traded on the exchanges just like a stock.
In general, an ETN is taxed the same as a bond. Upon a sale, the investor has a gain or loss that can be short-term or long-term, depending on how long the ETN was held.
The belief of most tax advisors is that owning an ETN that tracks gold or other collectibles shouldn’t be considered a collectible for tax purposes. You shouldn’t be subject to the maximum 28% long-term capital gains rate for shares held longer than one year, and you should be able to own the ETN in an IRA.
Likewise, if the ETN tracks futures contracts or the ETN issuer buys futures contracts to help meet its obligations under the ETN, the investor shouldn’t be treated as owning futures contracts.
Some ETNs make distributions while others don’t. Any distributions from the ETF are treated as interest income.
But there’s a lot of uncertainty about how ETNs are taxed, because the IRS hasn’t issued definitive rules. It issued a ruling in 2008 that raised more questions than it answered. The IRS has said it is considering a number of tax issues related to ETNs.
Equities. An investor can purchase the shares of companies that mine and produce gold and perhaps other metals.
For tax purposes, shares of gold mining companies are treated the same as other stocks, not as collectibles. When owned in taxable accounts, they qualify for the regular maximum long-term capital gains rate when held for more than one year, not the collectibles tax rate. Shorter holding periods result in short-term capital gains. Losses also are deducted the same as capital losses on other stock shares.
Gold mining company shares can be purchased individually, through open-end mutual funds, or through ETFs.
The returns of gold-related investments vary depending on the choice of investment vehicle. The tax treatment also varies between the vehicles, so investors’ after-tax returns can differ significantly even when the investments have the same pre-tax returns. There are special rules about owning gold in an IRA or other retirement account, which I’ll discuss in a future post.