Given the billions of dollars poured into gold investments over the past decade, most financial planners have clients with exposure to the metal in some form. Advisors of gold buyers, beware: To help clients avoid surprisingly steep tax bills and IRS penalties, knowledge of the tax law can be vital.

CAPITAL IDEAS

Historically, clients who wanted an allocation to gold would invest in gold stocks or mutual funds holding those stocks. Recently, though, most of the inflows have gone to ETFs such as SPDR Gold Shares (GLD) and iShares Gold Trust (IAU), which together had more than $70 billion in assets as of Jan. 12. What's tricky is that these giants are not taxed in the same way as mining stocks and mining mutual funds.

Investors who own gold mining stocks and precious metals mutual funds (which largely hold gold mining shares) are corporate shareholders, so they owe ordinary income tax on any short-term gains but no more than 15% on profits taken after a holding period of longer than one year. This year, taxpayers in the 10% or 15% ordinary tax brackets owe nothing on long-term capital gains, including gains from gold mining shares.

But the GLD and IAU funds are different. "Long-term gains on the sale of IAU are taxed as collectibles gains," says Kevin Feldman, a managing director at BlackRock, which owns iShares. GLD gets the same tax treatment. These ETFs are of the type that buy and hold gold bullion, which is stored in vaults, so investors essentially own a share of the gold.

The IRS says a "gain or loss from the sale or trade of a work of art, rug, antique, metal (such as gold, silver and platinum bullion), gem, stamp, coin or alcoholic beverage held more than one year" is treated as a collectibles gain or loss. "Collectibles gains do not qualify for the 0% or the 15% capital gain rates," says Bob Scharin, a senior tax analyst at Thomson Reuters in New York. Consequently, investors with long-term gains from bullion funds as well as from other forms of gold, such as coins or bars, owe more tax than investors who profit from corporate shares.

MAXIMUM MATH

Long-term collectibles gains may be taxed as high as 28%, rather than 15%. According to the IRS, the 28% tax rate is a maximum rate, not a flat rate. Taxpayers pay tax at their ordinary rate on long-term collectibles gains (including gains from gold), but no more than 28%.

In other words, sellers of gold and gold bullion ETFs owe 10% if they're in a 10% tax bracket, 15% if they're in a 15% tax bracket and 25% if they're in a 25% bracket. Only taxpayers in the 28%, 33% or 35% tax brackets owe 28% on long-term gains from gold. This year, that maximum tax on collectibles affects clients with taxable income of more than $85,650, or married couples with taxable income of more than $142,700.

Fortunately, planners and clients may be able to deal with this tax issue by using loss-harvesting strategies to offset the collectibles gains. Collectibles gains don't qualify for the 0% or 15% rates, but they are still treated as capital gains. Net short-term capital losses and net long-term capital losses can be used to offset collectibles gains.

"A gold capital gain can be offset by a stock capital loss," says David Beahm, a vice president at Blanchard, a gold dealer based in New Orleans. Consequently, a net capital loss that usually saves 15% in tax can be used to save up to 28% in tax on gains from gold.

NORTHERN EXPOSURE

Beyond loss harvesting, there may be other ways to reduce the tax on selling gold. Some closed-end funds based in Canada (such as Sprott Physical Gold Trust and Central Gold Trust) hold gold bullion while others (such as Central Fund of Canada) hold silver bullion as well as gold. These funds generally are available to U.S. investors, and advise that long-term gains may be taxed at 15% instead of a maximum 28%.

To achieve this tax rate, investors must designate the trust units as qualified election funds in a timely fashion, according to a sales prospectus from Sprott. A representative of Central Fund of Canada also notes that investors who make the qualified election funds choice will be eligible for the 15% rate.

Yet the tax status is hardly black and white. "The law is quite clear on the taxation of collectibles, regardless of the source," a spokesman for the IRS said in an email. "There is such a thing as a QEF, but that doesn't mean that it's relevant."