What are considered precious metals for investment purposes?

For investment purposes, precious metals are traditionally considered the chemical elements gold, silver, platinum and palladium. Apart from most all other elements, the “precious metals,” like gold, silver and, to a much lesser degree, platinum, are the most common hard asset investment options given their historical use as currency by nations. Thus, these metals are highly sought after materials as stores of wealth that historically have held value over time against other forms of investments, and especially as compared to the value of paper currencies.

Investors can invest in precious metals both directly by purchasing the asset in the form of actual bullion or in coins, or by investing in the stock of companies that either invest in precious metals or produce them. Another way to invest in precious metals is to purchase precious metal ETFs (exchanged-traded funds).

In general, the IRS generally deems a precious metal asset investment a “collectible” and thereby a capital asset for income tax purposes. Hence, a net sale profit or loss is taxed as a capital gain or loss, and as either long-term or short-term. For long-term capital gains, the applicable tax rate in 2013 and beyond is based upon the ordinary income tax rate of the taxpayer. Further, for taxpayers with income in excess of $250,000 (joint returns) or $200,000 (single returns), the additional 3.8% investment income tax (the 3.8% net investment income tax, or NIIT) is added to the otherwise applicable capital gains rate.

How may an individual invest in precious metals?

Depending on the metal, investments may be made in two or three ways. In the case of gold or silver, an investor may purchase gold or silver bullion-type coins, bars, or certificates that certify that a specific amount of the metal is housed in a specific warehouse for the investor. In the case of other metals, such as platinum or palladium, investments are made by the purchase of bars or certificates.

Each method of investing in precious metals has its advantages and disadvantages.

If an investor acquires bullion-type coins in a taxable transaction (such as in a non-like-kind exchange or as payment of a stock dividend or for services rendered), the coins will be valued at fair market value, not face value, for purposes of that transaction.

In summary, each combination of metal and investment option carries certain advantages and disadvantages. Some precious metals may have more established markets. Other precious metals may have industrial purposes that can both hurt or help the value of the investment at any given moment, whether an investor is buying or selling in the market. Use of a qualified retirement plan vehicle for acquisition may or may not be appropriate and carries its own separate set of considerations and limitations. All these factors must be considered when making precious metals investments.

Can a taxpayer hold precious metals in an IRA?

The list of precious metals that may be held in an IRA is specific. Both life insurance and collectibles cannot be held in an IRA and, according to the IRS, “if you invest your IRA in collectibles, the amount invested is considered distributed in the year invested and you may have to pay a 10% additional tax on early distributions.” In effect, the transaction is treated as a premature taxable distribution. Therefore, investment assets in an IRA must be carefully selected, especially if they are precious metals.

Here are some examples of prohibited collectibles by the IRS:

Artwork, rugs, metals (but there are exceptions for certain kinds of bullion that meet specific requirements), coins (but there are exceptions for certain coins that meet specific requirements), antiques, gems, stamps, alcoholic beverages, and certain other tangible personal property.

More detailed information on an IRA investment in permitted and prohibited precious metals “collectibles” is contained in IRS Publication 590, Individual Retirement Arrangements (IRAs). According to IRC Section 408, an IRA can include any “gold, silver, platinum, or palladium of a fineness equal to or exceeding the minimum fineness that a contract market (as described in the Commodity Exchange Act) requires for metals which may be delivered in satisfaction of a regulated futures contract.” Investors should always work with an IRA administrator/custodian experienced with permissible IRC Section 408(m)(3) precious metals to avoid adverse tax consequences to the IRA, and its participant(s).

It should be noted, that the DOL’s “fiduciary” regulations, released in April 2016, could make an advisor who sells or recommends products, as well as provides advice on investments to the owner of an IRA, an investment advisor fiduciary under ERISA subject to greatly expanded liabilities. This application of the ERISA fiduciary rules to IRAs is brand new. The exemptions to this proposed ERISA fiduciary rule impose significant preconditions on both the advisor and any provider financial institution, and have the potential for changing the available forms of advisor compensation.

What is a collectible?

In the broad sense, a “collectible” is any item of property that derives its value directly from its rarity and popularity. An item’s history, condition, composition, artistic and aesthetic qualities, and the number of similar items in existence may each play a part in determining the value of a particular collectible. However, the presence or absence of a ready market where the item may be traded will have a great deal to do with whether a particular class of property is an investment quality collectible. Common investment quality collectibles include rare coins and currencies, works of art, metal or gems, and stamps. Oriental rugs, antiques, and certain alcoholic beverages are also often held as investments.

In regard to coins, there are two types of coins held for investment purposes. Numismatic coins derive their value from qualities, such as condition and number minted, which make them rare; metal content is only one of many elements contributing to the value of such numismatic (or rare) coins. On the other hand, bullion-type coins (such as the Canadian Maple Leaf, the Mexican Peso, and the Austrian Corona) derive their value solely from their metal content (although a striking premium may also be added into the market value); they represent investments in the world gold or silver markets rather than in the coins themselves.

In either case, however, the coins should generally be treated as “collectibles” for tax law purposes, in the same way that a gemstone, stamp, artwork or a vintage wine is a collectible. Even if a bullion-type coin is not a “coin” within the meaning of IRC Section 408(m)(2)(D), it ought to fall within the category of “any metal or gem” under IRC Section 408(m)(2)(C). However, the IRC exempts certain coins issued by the United States or an American state from the definition of “collectible,” such as gold coins issued by the U.S. and real silver dollars of the “old-fashioned type.”

When a collectible is sold, how is the transaction taxed?

Except for tax rates applied to a taxable gain, no special tax rules apply to sales of collectibles held for investment. Therefore, to the extent that the selling price received exceeds the individual’s tax basis in the collectible, he or she must report a taxable gain; if the individual’s basis in the collectible exceeds the selling price, he or she may report a loss from the transaction (still assuming, that is, that the collectible was “held for investment”). Collectibles gain (i.e., gain on the sale or exchange of a collectible that is a capital asset held for more than one year is subject to separate treatment from other capital gains and losses, which generally results in its being subject to a capital gain rate less favorable than the generally applicable rate, but more favorable than the rate for ordinary income.

If the entire purchase price for the collectible is received in the taxable year of sale, the gain (or loss) must be reported on that year’s income tax return; otherwise, the installment sale rules will apply.. Beginning in 2013, the net capital gain may also be subject to the 3.8% Medicare tax on “net investment income” as defined in IRC Section 1441, depending upon the taxpayer’s modified adjusted income.

— Read more from 23 Days of Tax Planning Advice: 2017 on ThinkAdvisor.