Given the billions of dollars poured into gold investments over the past decade, most financial planners have clients with exposure to the metal in some form. Advisors of gold buyers, beware: To help clients avoid surprisingly steep tax bills and IRS penalties, knowledge of the tax law can be vital.
Historically, clients who wanted an allocation to gold would invest in gold stocks or mutual funds holding those stocks. Recently, though, most of the inflows have gone to ETFs such as SPDR Gold Shares (GLD) and iShares Gold Trust (IAU), which together had more than $70 billion in assets as of Jan. 12. What's tricky is that these giants are not taxed in the same way as mining stocks and mining mutual funds.
Investors who own gold mining stocks and precious metals mutual funds (which largely hold gold mining shares) are corporate shareholders, so they owe ordinary income tax on any short-term gains but no more than 15% on profits taken after a holding period of longer than one year. This year, taxpayers in the 10% or 15% ordinary tax brackets owe nothing on long-term capital gains, including gains from gold mining shares.
But the GLD and IAU funds are different. "Long-term gains on the sale of IAU are taxed as collectibles gains," says Kevin Feldman, a managing director at BlackRock, which owns iShares. GLD gets the same tax treatment. These ETFs are of the type that buy and hold gold bullion, which is stored in vaults, so investors essentially own a share of the gold.
The IRS says a "gain or loss from the sale or trade of a work of art, rug, antique, metal (such as gold, silver and platinum bullion), gem, stamp, coin or alcoholic beverage held more than one year" is treated as a collectibles gain or loss. "Collectibles gains do not qualify for the 0% or the 15% capital gain rates," says Bob Scharin, a senior tax analyst at Thomson Reuters in New York. Consequently, investors with long-term gains from bullion funds as well as from other forms of gold, such as coins or bars, owe more tax than investors who profit from corporate shares.
Long-term collectibles gains may be taxed as high as 28%, rather than 15%. According to the IRS, the 28% tax rate is a maximum rate, not a flat rate. Taxpayers pay tax at their ordinary rate on long-term collectibles gains (including gains from gold), but no more than 28%.
In other words, sellers of gold and gold bullion ETFs owe 10% if they're in a 10% tax bracket, 15% if they're in a 15% tax bracket and 25% if they're in a 25% bracket. Only taxpayers in the 28%, 33% or 35% tax brackets owe 28% on long-term gains from gold. This year, that maximum tax on collectibles affects clients with taxable income of more than $85,650, or married couples with taxable income of more than $142,700.
Fortunately, planners and clients may be able to deal with this tax issue by using loss-harvesting strategies to offset the collectibles gains. Collectibles gains don't qualify for the 0% or 15% rates, but they are still treated as capital gains. Net short-term capital losses and net long-term capital losses can be used to offset collectibles gains.
"A gold capital gain can be offset by a stock capital loss," says David Beahm, a vice president at Blanchard, a gold dealer based in New Orleans. Consequently, a net capital loss that usually saves 15% in tax can be used to save up to 28% in tax on gains from gold.
Beyond loss harvesting, there may be other ways to reduce the tax on selling gold. Some closed-end funds based in Canada (such as Sprott Physical Gold Trust and Central Gold Trust) hold gold bullion while others (such as Central Fund of Canada) hold silver bullion as well as gold. These funds generally are available to U.S. investors, and advise that long-term gains may be taxed at 15% instead of a maximum 28%.
To achieve this tax rate, investors must designate the trust units as qualified election funds in a timely fashion, according to a sales prospectus from Sprott. A representative of Central Fund of Canada also notes that investors who make the qualified election funds choice will be eligible for the 15% rate.
Yet the tax status is hardly black and white. "The law is quite clear on the taxation of collectibles, regardless of the source," a spokesman for the IRS said in an email. "There is such a thing as a QEF, but that doesn't mean that it's relevant."
Planners may prefer not to take sides on the issue. "I have read conflicting information and the IRS guidance is not clear," says Loyd Stegent, founding director of Cornelius Stegent & Price, a CPA firm in Houston. Stegent, who's also president of an associated fee-only investment and financial counseling firm, Stegent Equity Advisors, says some clients own Sprott Physical Gold Trust, Central Gold Trust and Central Fund of Canada.
"For my clients," he says, "I try to avoid the tax problem by keeping bullion ETFs and closed-end funds in their IRAs. There is no filing requirement if these are held in an IRA."
Similarly, Jeff Waters, managing member of OFC Financial Planning in Short Hills, N.J., says he has been an "active investor" in GLD for several years. "I have been citing the 28% tax issue to clients for quite some time and try to locate their GLD holdings in tax-deferred accounts when I can."
Holding collectibles such as gold bullion funds in an IRA defers the tax on any sale, perhaps for decades. All IRA withdrawals are taxed at ordinary rates so that any profits from GLD will be taxed the same way as profits from conventional stocks or stock funds when the money is eventually distributed.
Nevertheless, putting gold investments in IRAs raises additional tax issues for clients. Holding mining stocks and precious metals funds pose no problems. However, the IRS states emphatically that "the law does not permit IRA funds to be invested in collectibles."
If an investor makes a $5,000 IRA contribution this year and uses that money to buy a stamp collection, confident it will appreciate substantially over the years, the investor will have to report a $5,000 taxable distribution and perhaps a $500 (10%) surtax if he or she is younger than 59 1/2. According to the IRS, metals and coins are on the list of collectibles prohibited in IRAs, along with stamps, artwork, antiques - even alcoholic beverages.
The IRS also lists the collectibles that are permitted in IRAs. They include gold and silver coins minted by the U.S. Treasury, certain platinum coins and some types of bullion.
Barry Picker of Picker & Auerbach, a CPA firm in Brooklyn, N.Y., points to Section 408(m) of the tax code, which covers collectibles in an IRA. That section includes an exception for certain coins and bullion, specifically mentioning any gold, silver, platinum or palladium bullion equal to or exceeding the minimum fineness required for a contract under the Commodity Exchange Act. Gold coins that are at least 99.5% pure gold may be acceptable in IRAs.
KANGAROOS, NOT KRUGERRANDS
According to GoldStar Trust, an IRA custodian in Canyon, Texas, permissible IRA investments include Canadian Maple Leaf, Austrian Philharmonic and Australian Kangaroo or Nugget gold coins, in addition to American Eagles. South African Krugerrands are not acceptable, and neither are rare or collectible coins.
The tax code section mentioned by Picker goes on to state that the bullion must be in the physical possession of a trustee in order to be acceptable for IRAs. Therefore, clients who disdain various forms of "paper" gold and prefer to hold coins and bars won't be able to hold such gold in their retirement accounts. Beahm says that a multiparty process keeps IRA gold and clients at arms length.
"A client might contact us," Beahm says. "We would inform the client that he or she must work with a custodian that is willing to administer an IRA with precious metals, such as GoldStar. If the client agrees, GoldStar will direct Blanchard to purchase gold for that client's IRA. The gold is stored with Delaware Depositary Service, a licensed precious metals custody and distribution center."
Such a process involves fees to all the parties involved, so setting up this type of an IRA can easily be more expensive than an IRA with securities or bank accounts. Moreover, as Beahm explains, clients cannot put their hands on the physical gold in their IRAs.
"They would have to sell the gold to get a cash distribution," he says, "or they can take possession of the actual gold as a distribution." Clients generally will owe tax on a distribution from a traditional IRA.
FUNDS FIND FAVOR
By contrast, planners find it simpler to hold bullion funds in IRAs. "They're no problem for any custodian since they are listed securities," says Stegent, who uses gold ETFs and closed-ends in IRAs. Waters says he has never had an IRA custodian object to holding GLD.
"The IRS has ruled that the grantor trust structure is allowable for IRAs," says Kevin Quigg, New York-based head of ETF strategy and consulting at State Street Global Advisors, sponsor of GLD. Both GLD and IAU are structured as grantor trusts. In effect, the IRS has said that even though investors selling shares of such ETFs at a profit in a taxable account are subject to the tax rules on collectibles, buying those shares in an IRA will not be considered buying a collectible.
This tax code quirk is only one of many oddities that planners may have to face when clients invest in gold. Some precious metals mutual funds hold gold bullion in addition to mining stocks; if those funds sell their bullion at a profit, the gains will be passed through to investors and taxed at rates up to 28%. Other funds track the price of gold through futures contracts, so investors owe tax each year on unrealized gains, which are treated as 60% long-term and 40% short-term.
In short, very little is simple where gold investments are concerned. Whatever happens to the price per ounce, it pays for planners to do plenty of research before deciding on a gold strategy for clients.
Donald Jay Korn is a contributing writer at Financial Planning. His latest novel, In for a Pounding, is available on Kindle and Nook.