Exchange traded funds provide the average retail investor with the opportunity to easily access the commodities space. As the April 15 tax deadline approaches, investors should take the time to look over some tax consequences associated with commodity funds to minimize any potential pitfalls.
When an individual invests in a physically-backed precious metals ETF, like the SPDR Gold Shares (GLD), "the IRS treats you as if you were actually holding the bullion yourself," Michael Iachini, head of ETF research at Charles Schwab Investment Advisory, said in the article.
The IRS treats gold, silver and other precious metals as collectibles. Collectible metals are not taxed at the 15% maximum long-term capital gains rate, but instead, they are taxed at the ordinary income rate of up to 28%. If the precious metal ETF is held for less than a year, short-term rates can be up to 35%.
The IRS places a 60/40 split on futures-based ETFs, like the U.S. Oil Fund (USO), which are structured as limited partnerships. When sold, 60% of the profits is taxed at a maximum 15% long-term capital gains rate and 40% of the profits is taxed at short-term ordinary income rates. Additionally, unrealized gains on futures-based ETFs are marked-to-market annually - contracts held within the funds are taxed at the market value regardless of maturity at the end of the year.
Furthermore, futures-based ETF investors will receive a K-1 form from the fund provider that outlines gains from the shares, which you will have to pay taxes on.
Paul Justice, director of ETF research at Morningstar, notes that investors can hold these types of commodity ETFs in an IRA instead. While you would still owe standard tax on IRA withdrawals upon retirement, buying and selling commodity ETFs within an IRA does not trigger tax consequences.
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own GLD.
Disclosure: I am long GLD.