Inflation recently rose to 30-year highs, and that has generated more interest in investing in gold. The interest in gold is likely to continue until after central banks tighten monetary policy enough to slow economic growth. Political uncertainty and geopolitical tensions also increase interest in gold, explains Bob Carlson, editor of Retirement Watch.
A key to investing in gold successfully is to minimize taxes on your profits. Gold often is taxed differently than other investments, and the tax rules vary based on which of the many different ways to invest in gold you choose. Consider the tax effects of different choices before deciding how you want to own gold.
The classic way to invest in gold is to buy bullion. But bullion (whether gold or another metal) is designated as a collectible under the tax code, making it ineligible for regular long-term capital gains treatment.
Long-term gains on bullion are taxed at your ordinary income tax rate up to a maximum rate of 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.
In addition, collectibles, including bullion, cannot be owned in either a traditional or Roth IRA. The purchase of a collectible is a prohibited transaction and is treated as a distribution to the IRA owner. Bullion includes both coins and bars, whether you hold them yourself or have them stored at a facility. But some forms of bullion and coins are exempt from treatment as collectibles.
Coins that are legal tender in the United States, such as American Eagles, aren’t collectibles. Any coin issued under the laws of any state also is exempt. Bullion of a certain fineness also isn’t a collectible. To qualify for the exemption, the bullion or coins must be in the physical possession of a bank or approved non-bank trustee.
If an IRA purchases a non-exempt collectible, the purchase amount is included in the owner's gross income when the purchase was made, and there is a penalty for each year the investment stays in the IRA. If the owner is younger than 591⁄2, the amount invested in the collectible also is subject to the 10% early distribution penalty, unless the owner qualifies for an exception.
My recommended way to own gold is through exchange-traded funds (ETFs), because they are very liquid and have low costs. When you buy gold as an individual, you have to pay for insurance, storage and shipping. The ETF is likely to pay much less for these services and is likely to pay a lower bid/ask spread when buying and selling.
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 very modest premiums or discounts to net asset value. The IRS issued rulings to the ETFs about their tax treatment.
The shares of the ETFs are investments in collectibles for purposes of the capital gains tax rules. They’ll be taxed the same as bullion.
But under the IRA rules, shares of an ETF are not considered prohibited collectibles. Instead, the investor is purchasing shares of a fund because the shareowner does not have a legal claim on a share of the bullion held by the ETF and cannot force a distribution.
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.
A unique gold ETF is VanEck Merk Gold (OUNZ). Like IAU and GLD, OUNZ owns gold bullion and stores it in vaults (in London in this case). The unique feature is that investors can redeem their shares for bullion or bullion coins. (There is a fee for redemptions below a minimum level.)
Because of the ability to redeem shares for bullion, ownership of OUNZ by an IRA is treated as the direct purchase of a collectible.
You can trade gold futures yourself or own an ETF that does the trading, such as the Invesco DB Gold Fund (DGL). This fund attempts to track the return of a gold index by purchasing gold futures contracts. Though the fund’s returns should match the index’s returns, 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 an owner of a futures ETF is taxed just as if the owner held the individual futures contracts.
In futures ownership and trading, all gains 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.
DGL is organized as a partnership for tax purposes. That means gains and losses of the fund 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 any fund shares.
Futures through ETNs
Exchange-traded notes (ETNs) sometimes are an alternative to ETFs, though the number of ETNs is declining.
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 a stock. 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. Some ETNs make distributions while others don’t. 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, so their tax treatment isn’t certain.
Instead of investing in bullion or futures, an investor can purchase the shares of companies that mine and produce gold and perhaps other metals. Shares of gold mining companies are more volatile than the price of bullion, because mining companies have built-in leverage.
Once the fixed costs of mining are covered, most of each dollar increase in the price of bullion goes to profits. Likewise, most of each dollar decline in bullion sharply reduces profits. In addition, a mining company might borrow to finance production, and that increases leverage.
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, 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.