Gold's Tax Twist

Not even this year's volatile metal-price swings have been enough to stop overexcited gold bugs piling into the streetTracks Gold Shares(GLD Quote) exchange-traded fund.

In the last two months, the largest bullion ETF netted $794 million in new assets, bringing the total to $7.8 billion at the end of July, according to State Street Global Advisors, the firm that runs the fund.

But those eager investors may have a less-than-enthusiastic response to future tax bills if they haven't been reading the ETF's prospectus carefully.

That's because unlike stocks, which receive a maximum 15% tax rate on long-term gains, profits from trading bullion (bars or coins made of gold) are treated as "collectibles" by the Internal Revenue Service and get taxed at almost double the rate.

And although the GLD trades like a stock, it gets caught in the tax trap because it is backed up by holdings of gold bars, along with gold coins such as the American Eagle and the internationally popular South African krugerrand.

"If we are talking about collectibles, that's a maximum 28% tax rate," says Steven Melnik, director of graduate tax programs at City University of New York's Baruch College. "An unsophisticated investor could easily get lost in the shuffle, as they often do." He notes that short-term gains, which are generated from assets held less than a year, are taxed as ordinary income.

Even some professionals actively involved in the bullion market aren't familiar with this aspect of the tax code.

"I would bet that even most coin dealers would fail the test of that knowledge," says Mark Albarian, CEO of Santa Monica, Calif., coin merchant Goldline International. He doesn't believe that the categorization is necessarily appropriate for the ETFs. "It's hard to argue that a big block of gold is a collectible."