The Facts About the 28% Tax Rate on Gold and Collectibles
The tax code doesn’t treat all investments the same. Investment assets designated as collectibles, such as gold, are treated less favorably than many others. The following are listed as collectibles in the tax code: any work of art, any rug or antique, any metal or gem, any stamp or coin, and any alcoholic beverage. The tax code also says a collectible is “any tangible personal property that the IRS determines is a collectible.” The IRS issued proposed regulations that would add musical instruments and historical objects to the list.
The IRS also can decide during an audit that an asset is a collectible. If the taxpayer sold an asset at a gain, an IRS auditor could impose the higher rate plus interest and underpayment penalties. That’s a consideration for owners of assets such as antique automobiles, baseball cards and comic books. Collectibles are singled out for less favorable tax treatment in two areas. The first unfavorable treatment is that IRAs and other individually-directed retirement accounts aren’t allowed to own collectibles. I’ve discussed that in past issues of Retirement Watch and won’t address it here.
The second unfavorable treatment is that sales of collectibles have a maximum long-term capital gains tax rate of 28% instead of the 20% top rate for other investments. But the 28% tax is misunderstood and is what I will address this month. The prohibition of collectible ownership by retirement plans has exceptions for certain types of coins and bullion. Those exceptions don’t apply to the maximum long-term capital gains rate on collectibles. Exchange-traded funds that own or are backed by precious metals also are considered collectibles. Sales of shares of those funds face the higher long-term capital gains rate. You can verify an ETF’s tax status by reading the “Tax Risks” section of the fund’s prospectus.
Similar rules apply to partnerships that own collectibles. The different treatment of collectibles has existed since 1997 because Congress believes investments in collectibles don’t stimulate innovation or economic growth the way investments in financial assets do. Losses on sales of collectibles are deductible against either capital gains or other types of income when the asset was held for investment. When the collectible was held for personal, non-investment purposes, however, a loss isn’t deductible. Yet, when the asset is sold at a gain, the gain would be taxable even if a loss wouldn’t be deductible. Many people believe gains on collectibles are taxed at a 28% tax rate. But 28% is the maximum rate, and in many cases long-term gains from collectibles are taxed at a lower rate.
One reason a lower rate might be imposed is what’s known as the netting process. Before determining taxes on capital gains, a taxpayer first offsets, or nets, gains and losses against each other. First, the taxpayer separates sales of collectibles from sales of other investments. Then, in each category transactions are separated into those of assets held for one year or less (short-term gains and losses) and those from assets held for more than one year (long-term gains and losses). The short-term gains and losses are applied against each other to determine if there is a net short-term gain or loss and a net long-term gain or loss. Then, the net short-term gain or less is applied against the net long-term gain or loss for each category.
Suppose Max Profits, in his non-collectible investments, had $15,000 of short-term losses and $5,000 of shortterm gains. That’s a $10,000 net shortterm loss. Max also had $5,000 of long-term losses and $10,000 of long-term gains. That’s a net $5,000 long-term gain for the year. Finally, Max nets the $10,000 net short-term loss against the $5,000 net long-term gain to arrive at a net $5,000 short-term capital gain loss for the year in non-collectible investments.
After netting the non-collectible investment transactions, the collectible investment transactions are netted the same way. If there’s a net loss in the non-collectible category, it can be applied against a net gain in the collectibles. A long-term capital loss carryforward from previous years also can be applied against net gains in the collectibles.
You can see from this process that osses in non-collectible investments reduce taxable gains in collectibles. Only after the full netting process is the capital gains tax computed on the net gain or loss. Because the process of determining the tax rate can be complicated, I recommend using tax preparation software or a professional tax preparer. The IRS provides worksheets that can be helpful in the instructions for form Schedule D if you want to compute the tax yourself or estimate what the tax would be under different scenarios. While the maximum tax rate on longterm gains in collectibles is 28%, the tax rate isn’t a flat 28%.
First, the tax rate on long-term gains from collectibles isn’t higher than the taxpayer’s ordinary income tax rate. If the taxpayer’s regular bracket is less than 28%, then the tax rate on long-term gains in collectibles will be that lower rate. (If there’s a net short-term gain on collectibles, it always will be taxed at the taxpayer’s ordinary income tax rate.) The key point is that for most taxpayers the tax rate on long-term gains in collectibles is going to be 28% only if the taxpayer’s other income is high enough to push him or her into a regular tax bracket of 28% or higher. There are a few cases when a taxpayer will pay more than a 28% rate on net longterm gains in collectibles. This can happen when the taxpayer is subject to the alternative minimum tax.
It also can happen when the taxpayer takes the Section 199A qualified business income deduction available to the self-employed and some owners of pass-through entities such as partnerships and S corporations. The tax rate also might be higher when the taxpayer is subject to the 3.8% net investment income tax, because this surtax is imposed on higher-income taxpayers in addition to other taxes.
The taxpayer’s state also might impose an income tax on gains from collectibles. These rules provide opportunities to reduce or eliminate the tax on long-term gains from collectibles. One way to reduce the tax is to recognize a gain in collectibles over several years. This might not be realistic when the collectible is one asset that can’t be sold in stages.
But in other cases, it prevents having a large gain in one year that pushes the taxpayer into a higher bracket. You might sell a portion of the assets in December and another portion the following January. Another way to defer the gain over several years is the installment sale method. There are limitations on the use of the method, so don’t attempt this before consulting with a good tax advisor. Instead, of selling a collectible, you might want to donate it to a charity if you’re charitably inclined anyway.
When the collectible was a long-term investment asset, after making the donation you can deduct its fair market value without having to pay taxes on the gains. But for some collectibles, you take the charitable contribution deduction only if the charity is expected to use the asset in its charitable function and not sell it and use the cash. In addition, there might be an appraisal and other requirements for you to qualify for the tax deduction.
This is another strategy you don’t want to execute without first getting good tax advice. As with other capital gains, you can reduce the taxable gains on collectibles by selling other investments in which you have losses.
Harvest the losses to offset your gains. Of course, consider the collectibles in your estate planning. When there are substantial gains in the assets, you might want to continue holding them and let heirs inherit them through your estate.
They’ll be able to increase the tax basis to the current fair market value of the collectible and sell without owing any capital gains taxes. The collectibles would be included in the estate and potentially subject to estate taxes. The capital gains and estate taxes must be considered and balanced to determine the best strategy.
