Tag Archives: precious metals

Tax Treatment For Precious Metals

January 7, 2015 | By: Robert A. Green, CPA

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The collectibles tax rate on precious metals is high, learn how to improve after-tax returns.

There are many different ways to invest in precious metals and tax treatment varies.

Physical precious metals are “collectibles” which are a special class of capital assets. If collectibles are held over one year (long-term), sales are taxed at the “collectibles” tax rate — the taxpayer’s ordinary rate capped at 28%.

It’s different for regular capital assets like securities: individuals in the 10% and 15% ordinary income tax brackets pay 0% on long-term capital gains (LTCG); individuals in the 25%, 33% and 35% tax brackets pay 15% on LTCG; and individuals in the top 39.6% bracket pay 20% on LTCG.

This translates to materially higher tax rates on collectibles for all taxpayers in all tax brackets vs. regular LTCG tax rates. For this reason, many CPAs recommend clients invest in physical precious metals inside their IRAs. Congress and the IRS loosened the rules allowing IRAs to invest in precious metals.

If collectibles are held one year or less, the short-term capital gains ordinary tax rate applies no different from the regular STCG tax rate. Realized gains and losses in collectibles are reported on Form 8949 and Schedule D along with other capital gains and losses, which means the capital loss limitation of $3,000 against ordinary income applies on individual tax returns. There are special ordering rules for collectibles vs. other capital asset classes.

If you prefer the regular LTCG rate in your taxable accounts, you can get exposure to precious metals by investing in securities tied to the precious metals industry. These securities are no different from other securities with STCG up to 39.6% and LTCG rates up to 20%.

Traders appreciate precious metal futures since they are Section 1256 contracts with lower 60/40 tax rates and mark-to-market (MTM) accounting on a daily basis. Sixty percent is LTCG and 40% is STCG for a top blended rate of 28%, which is 12% less than the top STCG rate. MTM means you report both realized and unrealized gains and losses. The $3,000 capital loss limitation still applies. Alternatively, you may file a Section 1256 loss carryback election on top of Form 6781 when filing your tax return.

More about collectibles
When you invest in physical precious metals including bullion (coins and bars) or physical-backed precious metals ETFs — structured as grantor trusts which means you effectively own the bullion — the “collectibles” tax rate and rules apply.

Per Thomson Reuters Checkpoint tax research service:

  • “Collectibles gain or loss is gain or loss from the sale or exchange of a collectible which is a capital asset held for more than one year, but only to the extent such gain or loss is taken into account in computing gross income. (Code Sec. 1(h)(5)). Any work of art, rug or antique, (precious) metal or gem, stamp or coin, alcoholic beverage, or any other tangible personal property specified by IRS for this purpose is a collectible.” Precious metals jewelry meets the definition of collectibles.
  • “The term 28% rate gain means the sum of collectibles gain and losses and section 1202 gain (certain qualified small business stock), less the sum of collectibles loss, the net short-term capital loss for the tax year, and the long-term capital loss carryover to the tax year.RIA observation:As a result of the way the 28% rate gain is defined, a long-term capital loss carryover from an earlier tax year will always be used first to offset it.”

Examples: If X sells a collectible after one year and is in a low ordinary income tax bracket of 15%, then the collectibles tax rate is 15%. Conversely, if Y is in the ordinary tax bracket of 33%, the collectibles ordinary rate is capped at 28%. It’s not a blanket 28% rate for all taxpayers.

Nonphysical precious metal investments
If you want to avoid the higher collectibles tax rate and benefit from lower LTCG rates, consider investing in securities tied to precious metals, but not physically backed by precious metals.

For example, the popular gold ETF symbol GLD is a physical-backed precious metal ETF structured as a grantor trust and it’s deemed a collectible. Conversely, the gold mining ETF symbol GDX is a registered investment company (RIC) taxed as a security.

Here are some other examples of securities tied to precious metals: gold mining equities like symbols ABX and GG, gold mining ETFs (RICs) like GDXJ, gold mutual funds (RICs) like symbols SGGDX and TGLDX and gold mining exchange-traded notes (ETNs — debt securities) like symbols UBG and TBAR. Securities are not a pure-play investment in precious metals.

U.S. closed end funds (CEF) are also trusts treated as collectibles. But non-U.S. closed end funds like symbols CEF and GTU are offshore corporations subject to Passive Foreign Investment Company (PFIC) rules. For PFICs, consider a “qualified electing fund election” under Section 1295 filed on Form 8621 to enjoy LTCG tax rates. But unless you are making a significant investment, it may not be worth the extra tax red tape and oversight.

Section 1256 lower 60/40 capital gains tax rates
Traders always like Section 1256 because they get lower 60/40 tax rates even on fast trades; they don’t have to wait one year for lower LTCG rates. Gold futures contracts on U.S. futures and commodities exchanges qualify for Section 1256 tax treatment as regulated futures contracts (RFCs).

In their Journal of Accountancy article “Tax-Efficient Investing in Gold” dated Jan. 1, 2015, Steven H. Smith, Ph.D. and Ron Singleton, CPA, Ph.D. write that its also popular to invest in gold futures ETFs like symbols DGL and UGL, and gold futures ETNs. Our content on ETFs points out that sales of commodities/futures ETFs — structured as publically traded partnerships — are taxed like securities. Investors often receive a Schedule K-1 passing through Section 1256 contract income which requires an adjustment to cost basis as part of a sale transaction.

Breaking news from the IRS on IRAs and precious metals
Per Thomson Reuters tax service on Jan. 7, 2015, “IRAs can invest in trusts holding gold: In a private ruling, the IRS held that IRAs and individually directed accounts maintained by qualified retirement plans can invest in trusts holding gold without being treated as a distribution under IRC Sec. 408(m) (1). According to the IRS, the rules that prohibit direct investments by IRAs in gold do not apply if the gold is held by an independent trustee. In this ruling, shares in the trust are marketed to the public, including IRAs and individually directed plans, and are traded on a stock exchange. However, if the shares are redeemed for gold, the IRS says the exchange will be treated as an acquisition of a collectible (i.e., treated as a taxable distribution to the owner) except to the extent IRC Sec. 408(m)(3) is satisfied. PLR 201446030.”

The trend is your friend
When IRAs were created in 1974, Congress prohibited IRA investments in collectibles. In 1986, Congress allowed U.S. gold and silver coin investments and in 1998 it expanded that to pure (99.5%) bullion. In 2007, the IRS issued a PLR 200732026 that did not consider physical-backed precious metal ETFs like the GLD a collectible as held by IRAs — a clever way around the prohibition.

Expenses
Owning significant gold bullion requires expenses for storage and insurance. Holding a few gold coins in a safe deposit box has negligible cost. Even with securities and futures tied to precious metals, expenses are factored into the investment structures. Try to have IRAs and retirement plans pay their own investment expenses.

Bottom line
The price of gold had huge appreciation in the decade ending in 2012 and it’s been a rocky road down in price since then with volatility. Don’t lose sight of tax losses and the dreaded capital loss limitation, which applies to collectibles, precious-metal-tied securities and futures. At least you’ll get the benefit of losses inside a traditional IRA or retirement plan since it reduces your taxable distributions in retirement.

Postscript Feb. 26, 2015 about the option on GLD ETF
Many tax professionals treat the option on GLD (gold ETF) as a Section 1256 contract principally because it’s a non-equity option trading on a CFTC qualified board of exchange. Options on commodity ETFs structured as publicly-traded partnerships (PTP) are Section 1256 contracts. The GLD is a publicly-traded grantor trust, not a PTP. We understand that on their 2014 Form 1099Bs, Fidelity is treating the option on GLD as a stock option (a security) perhaps because if a taxpayer sells physical gold short term it’s a short-term capital gain just like a security. This may relate to the GLD being a grantor trust with disregarded ownership of the underlying assets – as if the owner of the ETF owns the gold bullion directly. A well respected tax information site Twenty-First.com lists the option on GLD as Section 1256 and it states “If the ETF is not set up as a RIC, but as a trust (like GLD) or a limited partnership (like USO), then listed options on the ETF would be treated as a non-equity option under Section 1256.” Click here for our content on ETFs.

Other Financial Products

August 29, 2014 | By: Robert A. Green, CPA

Traders have a bevy of financial products to choose from these days.

Foreign futures

Many foreign brokers promise Americans Section 1256 tax breaks on foreign futures. They mention Commodity Futures Trading Commission (CFTC) “no action letters” granting certain exchanges approval for marketing to Americans. These brokers overlook the other requirement: an IRS revenue ruling granting Section 1256 tax treatment to the foreign futures exchange. Only a handful of exchanges currently have this IRS revenue ruling, including Eurex, LIFFE, ICE Futures Europe, and ICE Futures Canada. (Read our blog Tax Treatment for Foreign Futures to see the list of exchanges with this IRS approval.) Remember, Section 1256 tax treatment uses MTM accounting at year-end. Foreign futures without Section 1256 are reported like securities.

Precious metals

There are many different ways to invest in precious metals, and tax treatment varies. Physical precious metals are “collectibles” which are a special class of capital assets. If collectibles are held over one year (long-term), sales are taxed at the “collectibles” tax rate — the taxpayer’s ordinary rate capped at 28%.

It’s different for regular capital assets like securities: individuals in the 10% and 12% ordinary income tax brackets pay 0% on long-term capital gains (LTCG); 15% LTCG rate for the middle brackets; and 20% for the top LTCG bracket. This translates to materially higher tax rates on collectibles for all taxpayers in all tax brackets vs. regular LTCG tax rates.

For this reason, some people invest in physical precious metals inside their IRAs. Several years ago, Congress and the IRS loosened the rules allowing IRAs to invest in precious metals.

If collectibles are held one year or less in a taxable account, the short-term capital gains ordinary tax rate applies no different from the regular STCG tax rate. Realized gains and losses in collectibles are reported on Form 8949 and Schedule D along with other capital gains and losses, which means the capital loss limitation of $3,000 against ordinary income applies on individual tax returns. There are special ordering rules for collectibles vs. other capital asset classes. Precious metals are not securities, so wash-sale loss adjustments, and Section 475 does not apply. Read our blog post: Tax Treatment For Precious Metals.

Volatility Products & Exchange Traded Notes (ETNs)

There are many different types of volatility-based financial products to trade, and tax treatment varies. For example, CBOE Volatility Index (VIX) futures are taxed as Section 1256 contracts with lower 60/40 MTM tax rates. The NYSE-traded SVXY is an ETF taxed as a security.

Volatility ETNs are structured as “prepaid forward contracts” or as “debt instruments.” Our tax counsel says that an ETN prepaid forward contract is not considered a security by the IRS, whereas, ETN debt instruments are.

Sales of ETN prepaid forward contracts use the realization method on sales. Long-term capital gains rates apply if held 12 months or longer. Because it’s not a security, ETN prepaid forward contracts (i.e., VXX) are not subject to wash-sale loss adjustments and Section 475 (if elected). ETNs debt instruments (i.e., UGAZ) are securities and are subject to wash sale losses and Section 475 (if elected).

There is substantial authority to treat CBOE-listed options on volatility ETNs, and on volatility ETFs structured as publicly traded partnerships as “non-equity options” with Section 1256 treatment. (See our blogs: How To Apply Lower Tax Rates To Volatility Options, and ETNs Have Different Structures With Varying Tax Treatment.)

In preparing Form 1099-Bs, many brokers use the tax classification determined by exchanges for labeling securities vs. 1256 contracts. Some brokers treat both types of ETNs as securities on 1099-Bs, even though prepaid forward contracts do not fall in that category. Some brokers treat CBOE-listed options on volatility ETNs and ETF PTPs as securities on Form 1099-Bs, even though they are eligible for Section 1256 treatment. Taxpayers can depart from 1099-Bs based on substantial authority positions and explain why in a tax return footnote.

Swap contracts

The Dodd-Frank financial regulation law promised to clear private swap transactions on exchanges to protect the markets from another swap-induced financial meltdown — remember those credit default swaps with insufficient margin? When Dodd-Frank was enacted, traders hoped that clearing on futures exchanges would allow Section 1256 tax treatment. They were wrong: Congress and the IRS immediately communicated that Section 1256 would not apply to swap transactions, and they confirmed ordinary gain or loss treatment.

Excerpt from Green’s 2019 Trader Tax Guide.