Since the turn of the millennium, the price of gold and other precious metals has risen sharply, bringing big profits to those who bought them early in their bull-market run. But as many people have found out recently, when it comes time to sell, the taxes you'll owe on your gold gains can be a lot bigger than you'd think.
Fortunately, there are some ways to own gold without paying an exorbitant tax bill. But to do so, you need to avoid a little-known IRS rule governing precious metals and other collectibles.
Capital gains, gold, and you
On any investment, the profit you make when you sell it counts as a capital gain. Hold an asset longer than a year, and that profit becomes a long-term capital gain. Most stocks and bonds currently enjoy a lower long-term capital gains rate of 0% for taxpayers in the 10% and 15% ordinary income tax brackets, 15% if you're in the 25% to 35% brackets, and 20% for top-bracket taxpayers.
But for collectibles, including gold, silver, and other precious metals, the rules are different. For long-term capital gains, you'll pay your ordinary income tax rate up to a maximum of 28%. That higher rate produces a much heftier tax liability, and given the big gains on gold investments over the past decade, gold investors have a lot of profits to get taxed.
Moreover, those collectible rates even apply to many exchange-traded funds that own gold and silver. The popular SPDR Gold (NYSEMKT:GLD), iShares Gold (NYSEMKT:IAU), and iShares Silver (NYSEMKT:SLV) all get treated the same as gold and silver bullion itself, and you'll owe the higher rate on gains.
A few solutions
But many tax professionals believe that some special gold and precious-metals investments have found a way to get the same beneficial tax treatment as regular stocks. Both Central Fund of Canada (NYSEMKT:CEF) and Sprott Physical Gold (NYSEMKT:PHYS) have structured themselves as passive foreign investment companies, for which a U.S. taxpayer can elect qualified capital-gain treatment and pay the lower maximum rate of 0% to 20%.
Another less complicated solution is to invest in gold mining companies rather than gold itself. Those companies definitely qualify for preferential capital-gain treatment. But lately, mining stocks have dramatically underperformed the price of the precious metals they produce, so they aren't a perfect solution, either.
Be tax-smart with your gold
Letting taxes dictate how you invest is often a bad idea, but by being aware of what taxes apply, you can take steps to reduce your eventual tax bill down the road. Those who picked the wrong way to invest in gold years ago can only regret the big portion of their profits that will go to Uncle Sam.
Fool contributor Dan Caplinger owns shares of Central Fund of Canada. You can follow him on Twitter: @DanCaplinger. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.