Gold, silver, aluminum, copper, heating oil, light crude, natural gas, RBOB gasoline, corn, soybeans, sugar, wheat, and zinc are among the more than 125 exchange-traded funds (ETFs) that invest in or hold commodities. To achieve their commodity positions, several commodity ETFs own futures contracts, while others possess the real commodity. Commodity ETFs are subject to special tax rules: The tax consequences for investors are influenced by the legal structure of commodity ETFs and the kind of ETF—futures contracts or actual commodities.
Holding commodity ETFs
Even if you do not sell your shares, you may face annual income tax concerns depending on how the ETF is constructed. Investors in a commodity ETF that is constituted like a partnership and owns commodity futures contracts face specific tax rules. Investors are required to report the ETF’s capital gains at a hybrid rate of 60% long-term and 40% short-term gains each year. This is true regardless of the ETF’s actual distributions. ETFs may potentially generate interest income for investors. The capital gains allocated to investors by futures-contracts ETFs are reported on a Schedule K-1 rather than a Form 1099 each year.
Commodity exchange-traded funds should not be confused with commodity exchange-traded notes (ETNs). These, too, can keep track of price movements in commodities. However, they are not subject to the 60/40 ratio when it comes to taxes. During the year, there are usually no dividends or interest payments. Rather, when ETN shares are sold, investors are taxed.
ETFs that hold physical commodities do not transfer earnings to investors, hence there is no annual tax cost for them. From a legal sense, these ETFs could resemble grantor trusts. The tax repercussions for investors arise only when they sell their ETF holdings.
IRAs are subject to a special rule. While collectibles are normally prohibited in IRAs, some US gold, silver, and platinum coins, as well as gold, silver, platinum, and palladium bullion, are allowed. IRA owners who desire to invest in precious metals can do so by investing in grantor investment trusts, which are classed as a type of IRA. IRA owners will be recognized as receiving a taxable dividend only if shares in ETFs holding the commodities are issued to them, according to a private IRS ruling. If you’re still unsure whether or not you can hold an ETF in your IRA, read the tax part of the fund’s prospectus, which is usually available online.
Selling commodity ETF holdings
When you sell shares in an ETF for a profit after holding them for more than a year, the capital gains tax rates are typically 0%, 15%, or 20%, depending on your taxable income and filing status. Commodity ETFs, on the other hand, may be regarded differently, depending on the type of ETF involved.
- Investors who sold futures-contracts ETF shares have already reported their profits, which were transferred on to investors and collected annually. When the shares are sold, there is usually no extra gain or loss to declare.
- For individuals in tax brackets at or above 28 percent, investors selling shares in commodity ETFs that hold physical gold or silver may be subject to a long-term capital gains rate of 28 percent. If these ETFs are grantor trusts, however, when investors sell their shares, they receive regular income rather than capital gain.
- The regular capital gain and loss regulations apply to investors who sell shares in commodity ETNs. Gains on the sale of currency ETNs, on the other hand, are taxed at regular income rates.
Note that, in addition to income tax, there may be a 3.8 percent Medicare surcharge. It applies to high-income investors’ net investment income. Commodity ETFs held in IRAs are exempt from this rule.
Final Word
Commodity ETF taxes is extremely tricky. As an investor, you can rely on the ETF issuer’s annual information return (e.g., a Schedule K-1 or a Form 1099) to outline your tax reporting responsibilities for the year. However, because your personal tax situation may have an impact on this tax reporting, it is critical to engage with a skilled tax professional to ensure that everything is done correctly!
Do you have to pay taxes on your ETFs?
Equity ETFs, which can include anywhere from 25 to over 7,000 different equities, are responsible for ETFs’ reputation for tax efficiency. In this way, equities ETFs are comparable to mutual funds, but they are generally more tax-efficient because they do not distribute a lot of capital gains.
This is due in part to the fact that most ETFs are managed passively by fund managers in relation to the performance of an index, whereas mutual funds are generally handled actively. When establishing or redeeming ETF shares, ETF managers have the option of decreasing capital gains.
Remember that ETFs that invest in dividend-paying companies will eventually release those dividends to shareholders—typically once a year, though dividend-focused ETFs may do so more regularly. ETFs that hold interest-paying bonds will release that interest to owners on a monthly basis in many situations. Dividends and interest payments from ETFs are taxed by the IRS in the same way as income from the underlying stocks or bonds, and the income is reflected on your 1099 statement.
Profits on ETFs sold at a profit are taxed in the same way as the underlying equities or bonds. You’ll owe an additional 3.8 percent Net Investment Income Tax if your overall modified adjusted gross income exceeds a certain threshold ($200,000 for single filers, $125,000 for married filing separately, $200,000 for head of household, and $250,000 for married filing jointly or a qualifying widow(er) with a dependent child) (NIIT). The NIIT is included in our discussion of maximum rates.
Equity and bond ETFs held for more than a year are taxed at long-term capital gains rates, which can be as high as 23.8 percent. Ordinary income rates, which peak out at 40.8 percent, apply to equity and bond ETFs held for less than a year.
What is the taxation on gold investments?
The price of gold has risen more than 17% so far in 2019 (as of 9/26/19), holding steady near $1,500 an ounce. We believe we are in the early stages of a new gold bull market. We believe, along with other precious metals strategists, that the yellow metal will surpass its all-time high of $1,900 in the next few years as investors face the realities of lower global interest rates for the foreseeable future, rising global debt, trade tensions, and mounting geopolitical uncertainty.
When actual gold — and other precious metals such as silver, platinum, and palladium — are sold, many U.S. investors are confronted with a grim surprise when it comes time to pay taxes on the profits. The cause is as follows: Gold and other precious metals are classified as “collectibles” by the Internal Revenue Service (IRS), and are subject to a 28 percent long-term capital gains tax. Gains on most other assets held for more than a year are subject to the long-term capital gains rates of 15% or 20%.
Collectibles are Taxed at 28%
This is true not only for gold coins and bars, but also for the majority of ETFs (exchange-traded funds), which are taxed at a rate of 28%. Many investors, including financial advisors, face difficulties when it comes to owning these assets. They wrongly assume that because the gold ETF trades like a stock, it will be taxed as a stock, with a long-term capital gains rate of 15% or 20%.
The high expenses of owning gold are sometimes seen by investors as dealer markups and storage fees for physical gold, or management fees and trading costs for gold ETFs. Taxes can be a large part of the cost of owning gold and other precious metals.
Fortunately, there is a simple way to reduce the tax implications of gold and other precious metals ownership.
PFICs are Taxed at 15% or 20% — A Tax-Friendly Way to Own Gold
Sprott Physical Bullion Trusts may provide better tax treatment for individual investors in the United States than comparable ETFs. Non-corporate investors in the United States are eligible for ordinary long-term capital gains rates on the sale or redemption of their units because the trusts are domiciled in Canada and classified as Passive Foreign Investment Companies (PFIC). For units owned for more than a year at the time of sale, these rates are 15 percent or 20 percent, depending on income.
To be eligible, investors — or their financial advisors — must complete IRS Form 8621 and file it with their U.S. income tax return to make a Qualifying Electing Fund (QEF) election for each trust.
While no one like filling out more tax papers, the tax benefits of holding gold through one of the Sprott Physical Bullion Trusts and making the annual election can be substantial.
How do ETFs get around paying taxes?
- Investors can use ETFs to get around a tax restriction that applies to mutual fund transactions when it comes to declaring capital gains.
- When a mutual fund sells assets in its portfolio, the capital gains are passed on to fund owners.
- ETFs, on the other hand, are designed so that such transactions do not result in taxable events for ETF shareholders.
- Furthermore, because there are so many ETFs that cover similar investment philosophies or benchmark indexes, it’s feasible to sidestep the wash-sale rule by using tax-loss harvesting.
What are some of the drawbacks of ETFs?
ETF managers are expected to match the investment performance of their funds to the indexes they monitor. That mission isn’t as simple as it appears. An ETF can deviate from its target index in a variety of ways. Investors may incur a cost as a result of the tracking inaccuracy.
Because indexes do not store cash, while ETFs do, some tracking error is to be expected. Fund managers typically save some cash in their portfolios to cover administrative costs and management fees. Furthermore, dividend timing is challenging since equities go ex-dividend one day and pay the dividend the next, whereas index providers presume dividends are reinvested on the same day the firm went ex-dividend. This is a particular issue for ETFs structured as unit investment trusts (UITs), which are prohibited by law from reinvesting earnings in more securities and must instead hold cash until a dividend is paid to UIT shareholders. ETFs will never be able to precisely mirror a desired index due to cash constraints.
ETFs structured as investment companies under the Investment Company Act of 1940 can depart from the index’s holdings at the fund manager’s discretion. Some indices include illiquid securities that a fund manager would be unable to purchase. In that instance, the fund manager will alter a portfolio by selecting liquid securities from a purchaseable index. The goal is to design a portfolio that has the same appearance and feel as the index and, hopefully, performs similarly. Nonetheless, ETF managers who vary from an index’s holdings often see the fund’s performance deviate as well.
Because of SEC limits on non-diversified funds, several indices include one or two dominant holdings that the ETF management cannot reproduce. Some companies have created targeted indexes that use an equal weighting methodology in order to generate a more diversified sector ETF and avoid the problem of concentrated securities. Equal weighting tackles the problem of concentrated positions, but it also introduces new issues, such as greater portfolio turnover and costs.
What is the best way to avoid paying capital gains tax on gold?
Make use of a 1031 Exchange. To begin, a 1031 exchange can be used to postpone your tax due. This means you reinvest the proceeds from your gold sale by purchasing more gold, and provided you meet IRS standards, none of these transactions will be taxed.
What is the maximum amount of gold you may sell before paying taxes?
What is the maximum amount of gold you may purchase without having to tell the IRS? What is the best way to record gold sales to the IRS?
If you want to benefit from the sale of gold in America, you must report your earnings to the tax authorities. As a result, you or your dealer must report your earnings to the IRS on Form 1099-B. You declare that you are neither a corporation or a corporate gold seller on the form.
Keep in mind that the tax responsibilities imposed on precious metals are not immediate. Instead, you’ll report the profits you make from selling actual gold on Form 1040 Schedule-D on your tax return.
The IRS requires you to submit returns if you sell 25 ounces or more of gold, such as Maple Leaf Gold, Mexican Onza coins, or the gold Krugerrand.
If you sell gold bars weighing one kilogram or 100 ounces, you must also declare them to the tax authorities. However, you are not required to fill out or submit Form 1099-B for the sales of Gold Eagle Coins. Your tax bill arrives at the same time as your income tax bill.
Is the gold ETF valuable?
Have you considered reducing your gold consumption? It’s important to remember that this is not an investment. Gold (and other precious metals) are classified by the IRS as collectibles rather than investments. If held for less than a year, gains from collections and investments are taxed as regular income. When the two are kept for more than a year, the tax treatment is quite different. Gains on investments are taxed at a maximum rate of 20%, while gains on collectibles are taxed at a rate of 28%. That’s more than a half-dozen times the tax!
The same requirement applies to physical gold-backed Exchange Traded Funds (ETFs). The gain on your gold ETF could be taxed as a collectable gain. The tax treatment of the ETF will be determined by how much of the fund is invested in physical gold versus a gold-linked asset. Even if an ETF owns only a small percentage of the physical commodity, it may qualify for investment tax treatment.
Even if you decide not to sell your gold ETF, the collectibles tax can still hit you. To cover operating expenditures, the ETF may need to sell part of its assets. Even if the shareholders do not get a cash distribution, any gains realized on the sale will be passed on to them. This is known as phantom income. To the IRS, paying tax on income you didn’t get makes perfect sense. Fortunately, none of this applies to precious metals mutual fund shares. This sort of fund’s capital gains and distributions are handled the same as any other mutual fund.
When assessing your precious metals holdings as part of your year-end investment evaluation, keep this information in mind. Nobody enjoys unpleasant surprises. Particularly when the unexpected arrives in the shape of income taxes.
Why are gold ETFs a bad investment?
As previously stated, you will not be able to own physical gold through this form of ETF.
When buying gold, you’ll have to pay fees up front, but you’ll have complete possession later. However, with gold ETFs, you’ll be charged for the duration of your investment.
You’ll have to deal with fees associated to marketing and management on a regular basis. When you decide to sell your fund, you’ll also have to pay taxes. This applies, much to the chagrin of investors, whenever you sell your gold ETF because the government deems it a taxable event. As you might expect, this defeats the purpose of purchasing a gold ETF in the first place.
In comparison to holding physical gold, the longer you retain this type of fund, the more money you’ll lose. Unlike a steel corporation, gold does not pay any dividends. As a result, you’ll have to pay for the upkeep of your investment on a regular basis.
If you’re on the fence about whether or not to invest in gold ETFs, this is something to think about.
Is it a good idea to buy a gold ETF?
When opposed to buying real gold, gold ETFs provide numerous advantages. The following are some of the characteristics of gold ETFs that make them a profitable investment option:
- Protect against inflation: Gold is regarded as a secure investment since it may be used to hedge against currency fluctuations and inflation.
- Trading is simple: To begin trading in gold ETFs, you must purchase a minimum of 1 unit of gold (equivalent to 1 gram of gold). The units can be bought and sold much like stocks, and you can do so through your stockbroker or an ETF fund manager.
- Gold prices on the stock exchange are open to the general public. Without any confusion, you can check gold prices for the day or the hour.
- Simple transactions: You can buy and sell gold ETFs at any time of day, from any location in the country, as long as the stock markets are open. You will also be unaffected by changes in gold prices caused by VAT or other taxes in different parts of the world.
- Gold ETFs with a stock market listing have no entry or exit load for buying or selling units. Brokerage fees are only about 0.5 to 1 percent of the total.
- Gold ETFs that are more than a year old are subject to long-term capital gains tax. Gold ETFs, on the other hand, are exempt from VAT, Wealth Tax, and Securities Transaction Tax.
- Gold ETFs are a safer investment than actual gold since they don’t have to worry about theft, secure storage, or payments like locker or making fees.
- Gold is a safe asset because its price does not vary very much. Even if your stocks returns decline, gold ETFs may protect you from significant losses.
- Diversification of your portfolio: Gold ETFs are a smart strategy to diversify your holdings. In the face of volatile market conditions, a diversified portfolio can help you earn better returns while lowering your risks.
- Loan collateral: If you wish to borrow money from a bank, you can use your gold ETFs as collateral.
You must exercise caution when investing in Gold Exchange Traded Funds, just as you would with stock market assets. Buying and selling on the spur of the moment might result in significant losses, which can have a negative impact on your investment portfolio. Rather than using gold ETFs as a daily profit-trading instrument, it is preferable to use them as safe assets and hedge investments.