Investing in Commodities, Tip 3: Watch Your Tax Rates
In commodities, there are a number of tax-related nuances that can catch investors off guard.
There's nothing to ruin a stellar investment call like a huge tax bill -- especially when it's unexpected. When it comes to investing in commodities through exchange-traded products or other strategies, there are a number of tax-related nuances that can catch investors off guard. It's worth the time to carefully research the tax implications of an investment before establishing a position, as the details of product structure can end up having a big impact on bottom line returns.
For example, physically-backed gold ETFs such as the Gold SPDR (GLD) are taxed at the collectibles rate of 28% regardless of the holding period, meaning that any profits earned from this precious metal will incur significant obligations to Uncle Sam. Another nuance relates to products that use futures to achieve their objectives and structure themselves as partnerships (PowerShares DB Commodity Index Tracking (DBC), United States Oil (USO), and United States Natural Gas (UNG) all fall into this category). These commodity ETPs will deliver a K-1 to investors at the end of the year, and will incur taxes at a blended rate of about 23% regardless of holding period. Moreover, tax liabilities are generally incurred on an annual basis -- even if you didn't sell a position.
Though some advisors may be hesitant to use ETNs due to the credit risk associated with these debt instruments, these vehicles can potentially offer some material tax advantages over other structures. ETNs are more "traditional" from a tax perspective in that they are taxed at the capital gains rates depending on holding period, and generally only incur a tax liability when a position is closed.
Bottom Line: The tax consequences of commodity investments can be confusing -- but incredibly important to bottom line returns.
This article is part of the series "Tips for Investing in Commodities." See also:
Tip 1: Futures Do Not Equal Spot
Tip 2: Commodities and Investments Can Align
Tip 4: China Can Make or Break You
Tip 5: Low Inventories Can Lead to Backwardation
Tip 6: Diversification Is Not a Given
Tip 7: Rolling Front Month Futures Is a Recipe for Disaster
Tip 8: More Than Just Energy and Gold
Tip 9: Watch Out for That K-1!
Tip 10: Consider Expenses Always
Tip 11: Commodity Exposure Through Stocks: Pros & Cons
Tip 12: Know What You're Getting Into
Tip 13: Consider Physical Exposure
Tip 14: Commodity ETFs: Structure Matters
Tip 15: Bigger Does Not Mean Better
Tip 16: Commodity ETFs Get a Bad Rap
Tip 17: Beware the Dollar's Impact
Tip 18: Not All Commodities Are Created Equal
Tip 19: Know Your Geography
Tip 20: Be Mindful of Your Timing
Tip 21: Platinum and Palladium Are the Other Precious Metals
Tip 22: Consider the COT Report
Tip 23: Remember That You Also Have Options
Tip 24: NAGS Vs. UNG -- Different Tools for Different Objectives
Tip 25: Free Resources Can Make Your Life Easier
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Editor's note: This article by Jared Cummans was originally published on Commodity HQ.