The IRS continues to issue positions on exchange-traded funds that hold gold and other precious metals.
Previously we reported good news for investors who owned gold ETFs in IRAs and other retirement accounts. The standard rules are retirement accounts are not allowed to purchase collectibles, and precious metals are collectibles. But the IRS ruled privately in 2007 that when an IRA owns the precious metals ETFs, the IRA is considered to own shares of a fund and not a direct interest in the precious metals. Owning the ETF is treated the same as owning a share of company stock or a mutual fund.
This ruling hinges on the ETF being formed as a trust. The shareholders of the ETF do not have claims on the bullion owned by the fund and can’t ask for distributions of the metal. You can find details of the rulings in the prospectuses for the ETFs. Keep in mind that private letter rulings are not precedent that can be cited by anyone other than the taxpayer to whom they were issued. But they do indicate the IRS’s thinking on an issue.
For investors who own gold ETFs through taxable accounts, the news is not as good. An internal IRS document, known as a Chief Counsel Memorandum, from 2008 that recently became public contained the bad news.
Taxable accounts are allowed to own collectibles and precious metals. But gains from sales on the assets do not qualify for the maximum 15% long-term capital gains rate. Instead, long-term capital gains from collectibles are taxed at a 28% rate.
This document says investors in the ETF are treated as having undivided interests in the metal owned by the ETF. If the ETF sells the metals, any gains pass through to the shareholders, and investors are treated as selling their share of the metal backing their shares. The distributions are taxed at the maximum 28% rate instead of the 15% rate if they qualify as long-term capital gains.
Likewise, if the investor sells shares in the ETF, the investor is treated as selling his or her share of the metal backing the shares. When the investor owned the shares for more than one year, the gains are taxed at the 28% rate instead of the 15% rate.
This is different from the rule for IRAs, and the IRS made no attempt to reconcile the two positions. The memorandum does say that the result is different if the ETF does not own physical metal or if it is not organized as a trust.
Note that neither of these positions is in IRS regulations or broad authority such as a Revenue Ruling. The position for IRAs was contained in Private Letter Rulings, and the taxable account position was in an Office of Chief Counsel Memorandum. For investors so inclined, either could be challenged in court. Taxpayers with a lot of money at stake who need certainty about the results can request Private Letter Rulings.
RW November 2009.