The Dark Side to Commodity Investments (ETFs) – Reporting the Tax Liability

July 14, 2011 by Mike Verville

Molly, a client of mine, just sent me a great Wall Street Journal article called “Exteme Tax Frustration” and it discusses tax consequences of commodity investing specifically “exchange-traded-funds” or ETFs.  As commodity prices soar, investors are rushing into the trendy ETF investment strategies (specializing in commodities like oil, currencies and gold).

ETFs can carry potential tax pitfalls such as higher tax prep fees, different tax rates and reporting requirements in various states.  A popular ETF that I have seen on clients’ tax returns, SPDR Gold Shares, is discussed in the Wall Street Journal article:

SPDR Gold Shares, for example, holds gold bullion in a “grantor trust.” As such, profits and losses aren’t claimed by the trust but “flow through” to holders and are taxed at their income-tax rates.

There is a big difference at tax time:  While holders of gold stocks in a mutual fund would pay tax on long-term capital gains (those held longer than a year) of 15%, long-term gains for Gold Shares holders are taxed at 28% because physical gold is a “collectible.”

Most ETFs are organized as partnerships and they issue a reporting statement called a K-1.  The K-1 is like a 1099 from a traditional brokerage account received at the end of the year but much longer and complex.  CPAs interviewed by the Wall Street Journal said each K-1 from an ETF can take up to an hour to input into a tax return.  The additional time necessary to understand and report an ETF investment adds to the tax preparation bill.

The article’s advice is:

For investors in commodity ETFs, tax surprises can dent or even erase the gains you thought you got. With these new products, the old adage “know what you own” may not be enough. You also need to know what you’ll owe.

Before you invest in ETFs, you may want to ask your broker or CPA about the tax consequences and estimated tax preparation fees regarding the investment.  As always, feel free to contact a professional at  Wallace Neumann & Verville, LLP and they can help determine the tax consequence of an ETF investment.

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