Investors have been pouring money into gold exchange-traded funds. In order to avoid surprises during tax season, however, it's important for investors to understand how different gold ETFs are taxed.

Bullion-backed Gold ETFs

Bullion-backed gold ETFs are structured as grantor trusts in which investors are considered to own undivided interests in the gold owned by the ETF. SPDR Gold Shares ( GLD), the largest example of a gold bullion-backed fund, is currently the second largest ETF when measured by assets. Other bullion-backed gold ETFs include iShares Comex Gold ( IAU) and ETFS Gold Trust ( SGOL).

Since investment in a bullion-backed ETF is treated as ownership of physical gold, ETFs like GLD, IAU and SGOL are taxed at the same maximum tax rate of 28% rate as collectibles (gold bars, baseball cards, etc.).

If an investor buys a bullion-backed gold ETF and holds it for more than one year, sale of the fund will be subject to the maximum tax rate of 28%. If an investor buys and sells shares of a bullion-backed ETF within one year, the investment is subject to ordinary income rates.

Investors may also be surprised to learn that they may incur gains or losses even if they simply buy and hold the fund. If an ETF like GLD or IAU sells gold to pay expenses, a common practice, the gains and losses of these sales are passed on to the investors. While investors do not receive distributions, they must include their share of profits in gross income, taxable at 28%.

Equity-Backed Gold ETFs

A less direct way to gain exposure to the gold market is through ownership of equity-backed gold funds. Funds like the Market Vectors Gold Miners ETF ( GDX) and the recently debuted Market Vectors Junior Gold Miners ETF ( GDXJ) provide exposure to a group of gold mining companies.

While the fortunes of these mining companies are certainly tied to the price of gold, they are not as "pure" a play on gold prices as bullion-backed funds like GLD.

When it comes to tax treatment, however, equity-backed funds are advantageous. GDX and GDXJ are subject to the 15% maximum tax treatment for long-term capital gains.

Futures-Backed Gold ETFs

ETFs that use futures to track the price of gold or silver are organized as master-feeder trusts. Investors in PowerShares DB Gold ( DGL) and PowerShares DB Silver ( DBS) are taxed as partners in a partnership.

As a shareholder of DGL, and a partner in the master-feeder trust, you will be liable to pay 60% long-term capital gains taxes and 40% short-term capital gains taxes for distributions. Investors may not even receive these distributions, as they are reinvested back into the ETF. Investors in DGL are also liable to be taxed on the ordinary interest income gained from the fund's collateralized Treasury bill positions.

ETNs

While there are no specific exchange-traded notes for tracking gold, funds like the iPath Dow Jones-AIG Commodities ETN ( DJP) and iPath Dow Jones-UBS Precious Metals Subindex Total Return ETN ( JJP) offer investors exposure to precious metals.

The tax treatment of ETNs is favorable for many long-term investors. ETNs are subject to capital gains taxes based upon when investors buy and sell the product. Rather than the periodic taxes faced by owners of bullion-backed and futures-backed gold funds, investors in ETNs only face this capital gains tax when they sell shares.

Since ETNs track underlying notes, rather than equities or futures, they are subject to the credit risk of the issuer. Many ETNs, like JJP, are also thinly traded and may be difficult for investors to trade in and out of.

Gold ETFs are a great way to diversify your portfolio, but it is important to consider the tax implications before selecting a fund. Talk to your tax adviser or evaluate your investment time frame before trading any gold ETF.
At the time of publication, Dion Money Management owned the Market Vectors Junior Gold Miners ETF and iShares Comex Gold.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.