YOUR MONEY-At tax time, gold ETFs punish investors
By Amy Feldman
NEW YORK, April 16 (Reuters) - Were you one of the many who were wooed by a gold exchange-traded fund (ETF) in 2011? Did another commodity ETF catch your eye (and your money)? Now that it's the season to calculate your capital gains and losses for tax purposes, you could be in for a major headache. And if you're thinking of loading up on these shares now, be aware that you could be buying yourself that tax headache for a future tax season.
ETFs, for the most part, offer tax advantages over traditional mutual funds because they tend not to distribute taxable capital gains as frequently. When investors sell stock or bond ETF shares, the resulting gains and losses are typically straightforward to calculate. Long-term gains from a stock ETF are taxed at a maximum rate of 15 percent, just as they would be if they came from a mutual fund or from selling shares of individual companies.
But when you own ETFs holding precious metals, oil or other commodities, taxes can get more complex - and the tax hit may be a lot higher than you expect.
"It's going to surprise people," says Michael Iachini, managing director of ETF Research at Charles Schwab Investment Advisory.
Here's what you need to know:
Gold, silver and other metals are considered collectibles like art or stamps for tax purposes, which means they are taxed at the special collectibles tax rate of 28 percent. (That's the long-term rate; short-term gains are taxed at income-tax rates just like other short-term capital gains.)
That tax quirk applies to ETFs if they own the underlying gold bullion - as do many popular ETFs, including SPDR Gold Shares and iShares Gold Trust, with a combined $78 billion in assets. Ouch! That means that if you made a long-term gain of $10,000 on a basic stock ETF and have no offsetting losses, you would pay $1,500 in federal taxes. The same gain in a gold bullion ETF would be $2,800.
These ETFs also may need to sell some of their holdings to pay operating expenses. If that happens, even though shareholders receive no distributions, they will still be taxed on any gains realized when that bullion got sold, and it will also be taxed at that special collectibles rate.
As with any other taxable gain, you will need to determine your cost basis - the starting price in the investment for tax purposes - on each of those sales. For these funds, you will receive 1099 forms that report your sales for tax purposes.
"We've seen a lot of gold ETFs this year, and we're pulling out the last few hairs we have over them," said Bill Fleming, a managing director in the personal financial services practice of PricewaterhouseCoopers. "A lot of ETFs have quarterly or monthly dispositions to pay for expenses. All of these are small dollar amounts, but you still have to figure out what your cost basis is."
An added paperwork complexity, Fleming notes, is that the new Form 8949, used to report capital gains and losses on your tax return to account for the new cost-basis rules, has no 28 percent column. You will still need to report those gains, figuring them on the 28 percent worksheet. All capital gains and losses information ultimately goes on Schedule D.
Commodities ETFs have proliferated over the past few years, with funds like U.S. Oil Fund, PowerShares DB Commodity Index Tracking, iShares S&P GSCI Commodity-Indexed Trust and the like. But while there may be good investment reasons to hold commodities, if you owned them last year you are now seeing their tax-time complexities.
Most of these funds are actually structured as limited partnerships and do not own the physical commodities - imagine having to store billions of dollars' worth of oil or wheat - but instead typically invest through futures contracts. The result is that you will get a K-1 partnership tax form rather than the simpler 1099, and you will owe tax under the special rules for commodities.
When you profit on commodities investments, your capital gains are considered 60 percent long-term (taxed at lower rates than ordinary income) and 40 percent short-term (taxed at your regular income tax rates), regardless of your holding period. So if you hold the ETF for just a few months, you will get a little break over the typical capital gains treatment. But if you hold it for the long term, you will still owe 40 percent of your gains at the higher short-term rate because of that special tax treatment. So, if you had that same $10,000 gain on the sale of a commodity ETF and no offsetting capital losses, you would owe $2,020 in taxes if you are in the 28 percent income tax bracket.
Making matters even more complex, the tax code requires open futures positions to be "marked to market" at the end of each calendar year. That means that all those futures positions are treated as if they were sold on the last business day of the year, with the resulting gains and losses taken, and re-established on the first business day of the new year. The result: You're on the hook to pay taxes on any reported gains due to this book-keeping, which will be outlined in the K-1 you receive.
As PwC's Fleming says: "These ETFs and publicly traded partnerships have a lot more complications than people might imagine."
If you're thinking of buying a gold ETF, read the prospectus carefully to see if it owns the bullion (which is more typical, but not always the case) or futures contracts. If you are looking at a commodities ETF, you will likely fall under the commodities rules above, but be prepared for complexity: The U.S. Oil Fund, for example, devotes 10 pages of its prospectus to tax considerations.
A quick-and-easy way to gauge the likely tax consequences is to look at the ETF's portfolio on the Morningstar website () to see if it is filled with hard assets or futures contracts. SPDR Gold Shares, for example, shows clearly that it holds 100 percent physical gold bullion, a clear sign that you will be taxed under the collectibles rules.
Finally, if you expect to have future gains at a higher-than-usual rate, you will want to give your tax strategy more attention this year. The tax rules allow you to offset capital gains with capital losses, but the special tax treatment of gold and commodities adds a little complexity to that matching.
That's because losses from stocks can offset gains from gold and commodities only after they have been used to offset gains from stocks. So if you expect to have gains this year on your gold ETFs, and you still have a slew of unrealized losses elsewhere in your portfolio, you may want to pay a little extra attention to tax-loss harvesting this year.