Many investors who prospered from gold’s bull market will be surprised by how profits on their gold investments are taxed.
Gold is a collectible in the tax code, giving it less favorable treatment than most other investments.
The first unfavorable treatment is that IRAs and other individually-directed retirement accounts (both traditional and Roth versions) aren’t allowed to own collectibles. The purchase of a collectible is treated as a distribution to the IRA owner. There are exceptions for certain types of coins and bullion. I won’t the treatment of collectibles in retirement accounts in detail in this post but discuss some major rules.
The second unfavorable treatment is that sales of collectibles in taxable accounts have a maximum long-term capital gains tax rate of 28% instead of the 20% top rate for other investments.
The exceptions for certain gold coins and bullion that apply to retirement plans don’t apply to the maximum long-term capital gains rate.
Exactly how gold is taxed varies based on how you choose to invest. I’ll review the major investment vehicles.
Bullion. The classic way to invest in gold is to buy bullion as either coins or bars that you either hold yourself or have stored at a facility.
Long-term gains on bullion are taxed at your ordinary income tax rate up to a maximum rate of 28%. That’s not a flat rate of 28%. Profits in gold are taxed at the lower of your ordinary income tax rate and 28%.
Short-term gains on bullion, like other investments, are taxed as ordinary income. An asset must be held for more than one year for any gains or losses to be long-term.
Before determining taxes on capital gains, a taxpayer first offsets, or nets, gains and losses against each other.
First, sales of collectibles are separated from sales of other investments. Then, in each category, transactions are separated into those held for one year or less (short-term gains and losses) and those held for more than one year (long-term gains and losses).
The short-term gains and losses are applied against each other to determine if there is a net short-term gain or loss. The same is done with long-term transactions.
Then, the net short-term gain or loss is applied against the net long-term gain or loss for each category.
Suppose an investor had $15,000 of losses and $5,000 of gains in his short-term non-collectible investments. That’s a $10,000 net short-term loss.
The investor also had in long-term non-collectible transactions $5,000 of losses and $10,000 of gains. That’s a net $5,000 long-term gain for the year.
The investor nets the $10,000 net short-term loss against the $5,000 net long-term gain to arrive at a net $5,000 short-term capital gain loss for the year in non-collectible investments.
The collectible investment transactions are netted the same way.
A net loss in the non-collectible category can be applied against a net gain in the collectibles. A long-term capital loss carryforward from previous years also can be applied against net gains in the collectibles.
Only after the full netting process is the capital gains tax computed on the net gain or loss. Through this process losses in non-collectible investments can reduce taxable gains in collectibles.
There are a few cases when a taxpayer will pay more than a 28% rate on net long-term gains from collectibles, such as when the alternative minimum tax applies or the taxpayer takes the Section 199A qualified business income deduction available to the self -employed and some owners of pass-through entities, such as partnerships and S corporations.
The tax rate also will be higher when the taxpayer is subject to the 3.8% net investment income tax.
The taxpayer’s state also might impose an income tax on gains from collectibles.
ETFs. A cheaper and more liquid way to own gold is through exchange-traded funds. The ETF is likely to pay much less than you for insurance, shipping, and storage and likely will pay a lower bid/ask spread when buying and selling.
The main gold ETFs are organized as trusts with ownership interests that trade on the stock exchanges.
You can buy or sell their shares any time the markets are open and as quickly as any stock. The ETFs generally trade at very modest premiums or discounts to net asset value.
The shares of the ETFs are investments in collectibles for purposes of the capital gains tax rules, according to IRS rulings. Sales of shares of the ETFs in taxable accounts will be taxed the same as bullion.
But shares of the ETFs are not considered prohibited collectibles for IRAs. The investor is purchasing shares of a fund. The shareowner does not have a legal claim on a share of the bullion held by the ETF and cannot force a distribution. If the ETF gives the investor a claim on gold and the right to force a distribution of bullion, then it is treated the same as direct ownership of bullion.
Futures. You can trade gold futures yourself or own an ETF that does the trading.
Futures contracts aren’t considered direct ownership of gold, so they aren’t collectibles, though not all IRA custodians allow futures investments.
Futures are taxed very differently from other investments, and an owner of a futures ETF is taxed just as if the owner held the individual futures contracts.
All gains in futures are treated as 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 taxes are computed on the paper gains and losses.
Most ETFs that trade futures contracts past their gains and losses 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 any fund shares.
Indirect ownership through ETNs. An ETN is a note, or debt, in which the note issuer (usually a major bank or broker) 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 benchmark. Shares of an ETN are traded on the exchanges just like stock shares.
If the firm backing the ETN has financial difficulties, the note might not be paid in full. Bankruptcy of the issuing firm could result in a complete loss.
In general, an ETN is taxed the same as a bond or bond fund. 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.
Any distributions from the ETF are treated as interest income.
Owning an ETN shouldn’t be treated as ownership of a collectible or a futures contract, regardless of the underlying asset tracked by the ETN. But the IRS hasn’t issued definitive rules on the taxation of 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. Gold miners’ shares can be owned in IRA.
When owned in taxable accounts, the shares 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.
Read the full article here
