Gold Tax Strategies

[Lone Wolf]

I have to start off by thanking craigr for this excellent forum.  Studying the Permanent Portfolio has been a most eye-opening experience.  Along with Harry Browne's original book, this forum and your website have been tremendous resources for me.  The whole thing has been damn exciting.

I've managed to settle on an approach for all of the asset classes at this point... except (you guessed it!) gold.  Stocks?  Pick a good index and let it ride.  Bonds?  TLT and 30-year treasuries, all held in tax-deferred accounts.  Cash?  A combination of T-bills, I-bonds, high-yield savings accounts, and a CD ladder (tax deferring what I can.)

But with gold, the 28% tax on collectibles is really sticking in my craw at the moment.  To me, gold is clearly money so the tax rate should actually be 0% (give or take 0%.)  I am really going to be grinding my teeth if\when gold breaks through a rebalancing band and I have to take this enormous tax bite on a sale.

Here are my options as I see them and I was wondering whether anyone could comment on what they do \ see as the best one.

• Lug around capital losses from year to year.  Thanks to 2001 and 2008, I have a number of nice, fat capital losses I can carry forward.  If I were forced to sell gold at some point in the future, could I not apply my capital loss against this capital gain on collectibles and thus avoid at least some of the 28% bite (up until the point when my capital losses are exhausted)?
• Hold a gold ETF in a tax-deferred account.   From what I've read, you would be subject to normal capital gains rather than the 28% collectible rate.  At least that seems to be what is implied in this ruling: http://www.irs.gov/pub/irs-wd/0732026.pdf.  Am I understanding this correctly?  (Edit: MediumTex set me straight here, see below.)  Does anyone stick a gold ETF in their IRA for this reason?  However, it seems that even with this nice bonus, cash instruments like SHV and SHY are better suited for the tax-deferred accounts than gold is (due to compounding.)  
• Stop whining and just pay the tax-man.  The above two options won't work and there is no way out of this.

Also, is there a good, comprehensive reference on what the "day to day" tax consequences of the ETFs like IAU and GLD are when you just hold them?  I understand that they occasionally have to sell a small amount of gold to cover their expenses but it's hard to imagine that this amounts to very much.  I'm assuming that the majority of the pain is when you sell and take a capital gain, but have I perhaps got that wrong?

[craigr]

I have had to rebalance gold and I do not have enough room in my tax deferred accounts to hold it. So I just end up paying the gains and match them up against losses as best as I can.

But overall rebalancing is not a frequent event. Sure, the volatility of the 2008/2009 markets caused rebalancing bands to be hit, but this kind of volatility is the exception. Additionally, if you are still contributing to your portfolio you may find that your new money additions can go into your lagging assets so rebalancing is further delayed.

Keep in mind that although the gold tax is 28%, it is not throwing interest and dividends at you each year the way stock funds and bonds will be doing. So yes there is a higher capital gains tax, but you are also able to defer paying it until you are ready to make the sale. It is not being forced on you like bonds and stock funds do each year.

It's impossible to avoid the tax man, but I've found the portfolio reasonably tax efficient all in all.

[MediumTex]

Buy some bullion outside your tax deferred accounts and shares of a gold ETF within your tax-deferred accounts.  Sell the ETF holdings when you hit a rebalancing band.

If you allocate 20% or so of your gold holdings to an ETF using this strategy it is likely to take care of most of any eventual rebalancing following an upward move in gold.  This approach should get you through at least one rebalancing.

Simple.

On the subject of the tax treatment of gold ETF shares in a tax deferred account, I believe the PLR you referenced indicated that the IRS would not seek to tax gold ETF gains in a tax deferred account prior to distribution (and would not apply the collectibles rate to any gains), and would treat distributions as ordinary income when they occur (not capital gains).  You may be thinking of the Canadian gold funds that are not subject to the collectibles tax and are instead taxed at the capital gains rates.

You are right when you say that learning about the PP is exciting.  It's rare in life to find something that works so well that so few people know about (and even fewer actually use).

[Lone Wolf]

Thanks gentlemen, these answers really help!  I have to keep this in proper perspective.  It's not like I'll be cashing out big jangling bags of Krugerrands every 3 months and watching 28% of my profits go up in smoke.  So long as gold isn't going to the moon, I can let it do what it does best -- act as a store of value.

MediumTex, I like your strategy!  Simple and elegant.  If I hit the 35% band, shedding 20% of the holdings would beat it back down to 28%, which is darn close to balance.  So once I've filled out TLT with my tax-deferred accounts, I'll do 20-25% of my gold holdings tax-deferred account and use the rest of my tax-deferred for various "cash" instruments.

On the subject of the tax treatment of gold ETF shares in a tax deferred account, I believe the PLR you referenced indicated that the IRS would not seek to tax gold ETF gains in a tax deferred account prior to distribution (and would not apply the collectibles rate to any gains), and would treat distributions as ordinary income when they occur (not capital gains).  You may be thinking of the Canadian gold funds that are not subject to the collectibles tax and are instead taxed at the capital gains rates.

I appreciate this extremely charitable interpretation of what I meant but unfortunately my statement was much sillier.  It appears that I was temporarily transported to la-la land and somehow thought that IRA distributions were taxed as capital gains (which makes no sense.)  Please forgive this exceedingly rank brain-fart... I suppose it has been a long day!

All right, I now know what to do.  All that's left is to gather up my courage to begin investing in physical gold bullion!

[MediumTex]

All right, I now know what to do.  All that's left is to gather up my courage to begin investing in physical gold bullion!

Adopting the PP strategy may be one of the smartest investment moves you will ever make.

However, as you get into it you may have second thoughts and reservations.  If you do, just move into it slowly and continue reading about how it works and the thinking behind its design.

With bullion in particular, if you haven't owned it before the first time you hold it in your hand it can be a strange experience and you may wonder how a few heavy yellow coins could possibly be part of a sophisticated investment allocation.  Over time, this sentiment will shift, and as you begin to deeply understand how gold fits into the overall strategy, you will never want to be without it (even if it goes through periods of poor performance).

[Lone Wolf]

Adopting the PP strategy may be one of the smartest investment moves you will ever make.

Smarter than investing nearly 100% in equities and getting my butt kicked up around my shoulders in 2001 and 2008?  The deuce you say! 

In my defense, I was a baby when I started down that path and that's what the investment world tells us babies to do.  In the traditional investment world, you "diversify" by buying some mid-cap stocks to go with your "aggressive growth" fund and you are good to go!  Why I was never tempted to think more deeply about this "strategy" (or investments in general) I'll never know.

However, as you get into it you may have second thoughts and reservations.  If you do, just move into it slowly and continue reading about how it works and the thinking behind its design.

With bullion in particular, if you haven't owned it before the first time you hold it in your hand it can be a strange experience and you may wonder how a few heavy yellow coins could possibly be part of a sophisticated investment allocation.  Over time, this sentiment will shift, and as you begin to deeply understand how gold fits into the overall strategy, you will never want to be without it (even if it goes through periods of poor performance).

After the shock of 2008, I took the time to study gold as money and grew very comfortable with the concept.  I still shunned it as an investment because "Who knows how much inflation there would be?  And this stuff is so darn volatile!"  I love that the Permanent Portfolio takes these exact characteristics (inflation fighting and terrifying volatility) and makes them fit as part of an overall weather-proof investment strategy.  The only hurdle I still have to get over is the gut reaction of, "Dude... this feels weird!"

Well.  That's not entirely true.  There's also the hurdle of "my wife looks at me like I am Scrooge McDuck when I talk about gold."    But fortunately the logic (and performance) of the Permanent Portfolio is softening that reaction substantially.

As for those periods of poor performance, my hope is that I will be buying gold when it is too expensive and my stocks and bonds will instead be going gangbusters.  This probably means a happier world in general (and the opportunity to buy more gold later on a rebalance!)  But in case things don't work out so well, I'll be so glad to have it.  Generally when you need gold in your portfolio... you really need it.

[MediumTex]

As for those periods of poor performance, my hope is that I will be buying gold when it is too expensive and my stocks and bonds will instead be going gangbusters.  This probably means a happier world in general (and the opportunity to buy more gold later on a rebalance!)  But in case things don't work out so well, I'll be so glad to have it.  Generally when you need gold in your portfolio... you really need it.

This is such an important point.  All PP investors should sincerely hope that gold does not perform well, because if gold isn't performing well it likely means we are living in a world where there is a sense of optimism and the markets are functioning in a more or less healthy manner.

I view gold like car insurance.  I don't buy car insurance because I expect to have a wreck--rather, I buy it because I know car wrecks happen all the time and I don't want to assume the risk without any protection.

[LNGTERMER]

Smarter than investing nearly 100% in equities and getting my butt kicked up around my shoulders in 2001 and 2008?  The deuce you say!  

In my defense, I was a baby when I started down that path and that's what the investment world tells us babies to do.

My story is very similar in  some ways. I got into stocks in late 90s and to my surprise every stock I bought started sky rocketing. I thought I was a genius, just to see my butt kicked in the dotcom crash, I held on being in a denial of course. After that I went on a journey of learning. The first book I picked up was touting technical analysis over fundamental analysis. So, I started investing in that approach. That came in handy in 08 by getting me out in time. Nevertheless, the ensuing crash did cement my search and desire for a fail safe approach, if such a thing existed.  I came across the PP early this year, read through the entire BG PP thread and once I started testing was won over by the PP. That mental adoption took more than simply testing of course, without the thoughtfulness people like craigr, MT and others have put into their arguments this could have simply been one more thread I read through for infotainment and move on, so my gratitude and thanks to them all. I switched all my investments at once into the PP in mid June of this year, and every morning when I wake up and look at my PP, see the stock market with a triple digit loses for example and then see my polio is up I have a smile in my face. I am a happy camper not only because of its performance so far but also because I did fully scope its draw downs and risks. Like you though my biggest hurdle is the gold part, for now I am holding the ETF, I am yet to come to grips with the idea of holding it in its physical form. I will keep reading so maybe that will change.

[MediumTex]

For anyone interested in reading a concise explanation of what happened starting in 2008 and what is continuing to happen today (and which will provide a more subtle appreciation of the PP strategy), please take a look at Chapter 20 ("Interest, Credit Expansion and the Trade Cycle") of Von Mises' "Human Action".  There is a link to it below.

Although Von Mises was writing this in the early 1960s (and before), it is eerie how prescient it seems.  It could have been written yesterday.

His overall argument is that what we are seeing today is simply the fallout from decisions and events that occurred long ago during the easy credit period of ascendance (as in the 1980s and 1990s).  Thus, the conclusion one must draw from his argument is that there is nothing that the government or monetary authorities can do at this point except make the scale of the disaster larger through a continued mis-diagnosis of the basic problem (which was the misallocation of capital resulting from artificially low interest rates).  In Von Mises' view, the "complete solution window" closed long ago (probably in the late 1990s) and at this point what we are experiencing is simply the late stage cancer that might appear decades after exposure to some carcinogenic material.

Think of artificially low interest rates as an economic carcinogen.

You may or may not agree with all of Von Mises' logic or conclusions, but he had a brilliant mind, and was probably the single most influential person on the development of HB's thinking.  There are others making his arguments today, but they don't normally provide the full exposition that Von Mises does.

http://mises.org/books/humanaction.pdf

[steve]

My gold tax stategy is: I hold about 7% in physical bullion and the rest to make it a 25% allocation I use GTU , I fill out the proper paper work: form 8621 along with updated attachment to form 8621  I elect To treat the PFIC as a QEF. I file this with my income tax and when it comes time to pay tax because of rebalancing it will not be taxed as a collectible. It will be a regular short or long term gain.

[Lone Wolf]

My gold tax stategy is: I hold about 7% in physical bullion and the rest to make it a 25% allocation I use GTU , I fill out the proper paper work: form 8621 along with updated attachment to form 8621  I elect To treat the PFIC as a QEF. I file this with my income tax and when it comes time to pay tax because of rebalancing it will not be taxed as a collectible. It will be a regular short or long term gain.

Thanks for the suggestion, Steve.  I sort of discarded GTU as an investment some time back when I realized that I had a very poor understanding of the net asset value premium's behavior.  My internal "you are in over your head" alarm started going off and I instead spent my time researching other alternatives (the IAU, GLD, and SGOL prospectuses left me with plenty of reading!)  How difficult do you find the form 8621 process?  Or, should I say, how difficult did you find it your first time out?

While I won't plunge into this one without gaining a deeper understanding, I appreciate the suggestion and will definitely add this to my list of things to learn more about.

For anyone interested in reading a concise explanation of what happened starting in 2008 and what is continuing to happen today (and which will provide a more subtle appreciation of the PP strategy), please take a look at Chapter 20 ("Interest, Credit Expansion and the Trade Cycle") of Von Mises' "Human Action".  There is a link to it below.

Medium Tex, thank you very much for posting this.  I kept meaning to come back and discuss these ideas but "Human Action" is an intimidating read.  In short, I completely agree with what Von Mises is saying here -- the false signals of artificially low interest rates cause malinvestment on a grand scale.  If prices are a signal and interest rates are the price at which an individual can borrow saved capital, artificially low interest rates (aka price manipulation) have to give birth to an economy with capital in "all the wrong places".

The good news is that I do believe that the economy will naturally purge these doomed projects and failed institutions (if allowed to do so) and enter a strong recovery.  I believe this is what we probably saw in the Depression of 1920.  The bad news is that this process could be extremely painful in the short term, as well as politically very difficult.

Frankly, the whole thing makes me want to put together a balanced and diversified portfolio.  But where to find such a portfolio?  Maybe they'll suggest something on CNBC.  I'll let you know what I find out.

[steve]

At first it was confusing. But after some research and seeing some filled out samples it became very simple. In fact it is really simple and the forms can be filled out in a matter of minutes. I would be happy to send you a filled out sample of the form 8621 and required attachment.  Each year you just send it in with your tax return.
As far as the understanding the premium and net asset value that is not really that complicated.
The net asset value is the total of the funds holdings divided by the shares issued. The value is the amount of gold the fund owns, (which translates to the number of Oz. of Gold multiplied by the spot gold price), the fund also has some cash that also has to be added, when you divide that total with the amount of outstanding shares or the number of shares that are issued you get the net asset value.  Now the premium is determined by the buyers and sellers. If more people want to buy shares then the number of people who want to sell shares the premium goes up. If there are more sellers than buyers the premium goes down.
I made an excel file that computes the current premium up to the minute by just putting in the spot price of gold,
This excel sheet also does PHYS and CEF. I would be happy to share.
Steve

[Lone Wolf]

Thanks, good to hear that it's not an excessively scary process.  Those both sound like handy resources if they are not too much trouble to post up!

On the net asset value premium, I was able to get comfortable with "what" it was but could never quite wrap my mind around the "why" on the premium fluctuation.  Why the fluctuation?  Was it some kind of variable demand for tax efficiency?  If so, would the coming tax increases make it less desirable and cause the premium to permanently drop (and thus cause my investment to lose value)?  In the end, I invoked "Rule #9: Don’t ever do anything you don’t understand" of the "16 Golden Rules of Financial Safety".  But perhaps a little more study down the line will get me more comfortable with the whole thing.