Despite
Record Gold Prices, Your Holdings May be Worth Less Than You
Think By Keith Fitz-Gerald,
Chief Investment Strategist, Money Morning | October 14, 2010
[Editor's
Note: Gold closed at a new high of $1,370.50 an ounce in New
York yesterday (Wednesday), the sixteenth record close in
the last five weeks. Money Morning's Keith Fitz-Gerald says
there's plenty more to come, too: In fact, he expects gold
to double in five years or less. But at the end of that stretch,
he warns, your profits may not be what you're expecting. Find
out why.]
Record gold prices are becoming an almost-daily
headline, with the "yellow metal" making a run at
$1,400 an ounce. And while this is great for the investors
who are along for the ride, there is an important caveat -
your gold may not be worth as much as you think it is.
Moreover, because of the tax consequences
of ownership, chances are it'll never add up to what those
guys hawking gold coins on late night TV lead you to believe.
But that doesn't mean you shouldn't invest.
With an estimated $202 trillion in unfunded pension liabilities
and the global public debt clock ticking higher, I believe
gold and other precious metals should be a part of every investor's
portfolio.
I believe gold is going to double in the next
five years and am not alone in my expectations that all metals
will be much higher - not in a straight line, mind you, but
higher than their current values. Legendary investor Jim Rogers
and U.S. Global Investors Inc. (Nasdaq: GROW) Chief Executive
Officer (CEO) Frank Holmes are just two of the experts who
have voiced similar opinions about higher gold prices in the
future.
So what's the problem?
According to the Internal Revenue Service
(IRS), gold is considered a collectible - a capital asset
with its own tax rate. This makes it no different from art,
antiques, stamps, certain coins, wines, or your favorite single-malt
scotch for that matter.
No doubt this will come as a rude surprise
for millions of people who think they are investing in the
precious metal. And if you think this isn't a big deal, think
again.
Gary E. Ham of the Beaverton, Ore.-based accounting firm of
Jones & Ham P.C., notes that gold does not qualify for
the 15% minimum tax bite that many investors consider routine
when calculating gains on investments held more than a year
(by that I'm referring to long-term capital gains).
Instead, profits from gold investments are
subject to a 28% maximum tax rate if held for more than 12
months. And, if those investments are sold in less than a
year, the profits from gold count as ordinary income, which
can also be taxed at far higher rates. (And those "higher"
rates could become a whole lot higher in the future, depending
upon what strategies present and future White House administrations
resort to in order to deal with the mounds of debt U.S. taxpayers
will be financing for generations to come.)
On the bright side, taxes aren't triggered
until there is a "taxable event," meaning you buy
or sell your gold.
It's worth noting that the same is true for
losses in that you can't use them to offset other taxes if
you haven't actually had a taxable event.
However, the same is not true for investors
who chose one of several popular metals exchange-traded funds
(ETFs) like the SPDR Gold Trust (NYSE: GLD), the iShares Silver
Trust (NYSE: SLV), or the iShares COMEX Gold Trust (NYSE:
IAU). Holders of these investments can be held accountable
every step of the way.
Precious metals ETFs are set up as something
called a "grantor trust," according to Barron's
and the IRS. This means that ETF investors are treated as
owning undivided interests in the actual metal that's owned
by the fund. Therefore, when the ETF sells some of its gold
for any reason, investors are liable for gains or losses from
the sale. And this has to be reported to the IRS as part of
gross income even if a cash distribution from the sale is
never received.
There also are wrinkles depending on how an
ETF achieves its objectives. For instance, both the PowerShares
DB Gold Fund (NYSE: DGL) and PowerShares Silver Fund (NYSE:
DBS) use futures contracts to mimic underlying direct gold
investments.
This means that they fall prey to something
the IRS calls the "mark-to-market" method, which
stipulates that any futures contracts held at the end of a
calendar year will be treated as if they were sold at fair
market value. This is called a "deemed sale."
Where this matters to investors is that each
shareholder is then, in turn, liable for his or her pro-rata
share of the taxes on the deemed sale even if the underlying
asset (the futures contracts the fund owns) haven't actually
been sold.
The one area of wiggle room still left to
investors who want to own precious metals funds, and who also
want to potentially mitigate the tax impacts of doing so,
is to hold such investments in their IRAs or 401(k) plans.
But - and I often get this question - coin
collectors should note that regular gold coins don't qualify.
The IRS says you can include only 24 karat gold bullion and
coins demonstrating a 0.995+ fineness and silver coins and
bars with 0.999+ fineness in tax-deferred accounts.
If you're beginning to get the idea that the
IRS wants a piece of your hide no matter how you invest in
precious metals, you're right. That's certainly the case,
and I can't possibly cover all the scenarios, so I'll end
with one final thought.
No matter whether you are just beginning to
invest in gold or have established a meaningful position in
the precious metal, please take a minute to talk with your
accountant or tax professional.
If gold doubles in five years or less - as
I expect it will - the last thing you'll want to do is hand
over a sizable portion of your gains to Uncle Sam just because
you made the right decision to preserve your wealth.