Tax implications of owning gold

As you might expect, there's very little that's straight-forward about the tax treatment of gold and other precious metals. (For the rest of this post, when I say gold, you can assume the same is true for silver and other precious metals.)

First of all, the IRS' perspective regarding owning physical gold, or any type of ETF backed by physical gold, is that you own a collectible rather than an investment. While gains from both investments and collectibles are taxed at your ordinary income rate if held less than 12 months, they are treated very differently if held longer than that. Investment gains are taxed at 15% if held longer than 12 months, but collectibles are taxed at 28% if held longer than 12 months. That's a significant difference.

Then there's the issue of owning gold in an IRA. Joseph detailed the convoluted process required to own physical gold within an IRA in this October article. But what about ETFs? Well, it stands to reason that if the IRS considers gold ETFs to be collectibles, and there's a rule against owning collectibles in an IRA, then you probably can't own gold ETFs in an IRA, right?

Wrong. That would be true, except that the IRS has made an exception for precious metal ETFs. The Money Girl website explains:

The IRS has made an exception for gold and silver ETFs held in an IRA. On August 10, 2007, the IRS privately ruled that shares of ETFs in the form of a trust that mirror the price of physical gold and silver do not constitute an acquisition of a collectible if they are acquired in an IRA. As a result, the IRS does not consider money invested in shares of gold and silver ETFs within an IRA to be a distribution subject to an early withdrawal penalty.

If the "trust" language in that description starts your spider-sense tingling, your instinct for detecting tax danger is well honed. Indeed, there are two main types of gold ETFs - those that are backed by the actual metal, and those that simply trade paper futures to approximate gold's price but which don't own the actual metal.

Austin briefly discussed this idea in the September cover article, A Road Map For Investing in Gold. The main point he was trying to convey was that even in the group of ETFs that are "asset-backed" you don't really know how much gold they hold, you just know they own some. (The implication of the ETF not being fully backed by physical gold is that you're counting on the ability of a counter-party to make good on their obligation, rather than having the security of owning the full amount of actual gold.) With the other group of ETFs, you can assume they don't own much physical metal at all. For tax purposes, the ETFs that don't own the metal get investment tax treatment, whereas the "asset-backed" ETFs get collectible tax treatment.

That's not all though. The asset-backed ETFs also can give you tax headaches of another variety. Like all other asset-backed ETFs (i.e., other commodity ETFs like oil, natural gas, etc.), when you buy an ETF like GLD (the iShares gold trust) or SLV (the iShares silver trust), you are treated as owning "undivided interests in the actual metal that's owned by the fund."

Money Morning explains why this can lead to big surprises:

Adding insult to injury, if the ETF sells some of its hard assets to pay expenses or management fees - as many have done recently, the resultant gains (or losses) flow directly through to investors and shareholders even if those investors don't receive any distribution or cash whatsoever.

And the net results can be mighty startling. For example, Doug Fabian, president of Fabian Wealth Strategies, a California-based investment advisor, noted several painful examples in an article on his firm's Web site about the tax traps of commodity ETFs, including:

• Another who had actual trading profits in the United States Natural Gas Fund LP (NYSE: UNG) of $1,900, with no interest received, and a K-1 reporting taxable profits of $4,319 and $120 in interest.
• An investor who had an enviable trading profit of $4,335 in the PowerShares DB Agriculture (NYSE: DBA), without receiving any interest - activity that triggered a K-1 form that reported profits of $6,963 and interest of $207.
• Finally, an investor who notched trading profits of $337 and no interest in the PowerShares DB Commodity Index Tracking Fund (NYSE: DBC) triggered a K-1 listing profits of $3,406 and interest of $195.

Scary.

The final group of gold investments we haven't discussed is precious metal mutual funds. Thankfully they are treated like any other mutual fund, so there's nothing fancy to be aware of there.

Obviously there's quite a bit to be aware of when you ultimately sell your gold holdings. Naturally, it's always a good idea to run your specific tax situation by a CPA or other tax adviser.
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Mark Biller is Sound Mind Investing's Executive Editor. Visit www.soundmindinvesting.com to learn more.