The Big Tax Trap
But those flaws pale in comparison with the “exciting feature” that ETFdb notes in its article: the tax treatment.
According to the fund's prospectus, “Any gains realized on the sale of units by an investor … may be taxable as long-term capital gains (at a maximum rate of 15% under current law).”
It sounds like the Holy Grail. One of the vexing problems of funds like the SPDR Gold Trust (NYSEArca: GLD) is that, no matter how long you own it, you will owe 28 percent taxes on gains because the IRS considers all gold investments to be collectibles. PHYS claims to have found a way around this problem, creating a gold bullion fund that qualifies for true long-term tax treatment. Brilliant!
Except it's not.
The IRS isn't stupid. It's going to get its money somewhere. And in this case, it looks like it's reaching into the pockets of PHYS' most loyal, buy-and-hold investors to grab that 28 percent for the U.S. Treasury.
Understanding why gets into the weeds of the prospectus, but it's important to do, because the implications are huge. Here's the relevant paragraph:
Let me parse that for you.
You, Mr. Long-Term Buy-and-Hold, purchase shares of PHYS and stuff them deep in your portfolio, confident that you'll only pay long-term gains of 15 percent when you eventually decide to sell. Meanwhile, a hedge fund buys shares of PHYS, rides them while gold is rising, and then redeems them back to the fund company.
To meet this redemption, the trust either sells a pile of gold to pay cash or redeems out physical gold bars. Either way, the trust will book that sale with the IRS based on the current price as gold, and will be taxed at the 28 percent collectible rate on any gains. But funds never actually pay taxes: They pass them along to shareholders. So that 28 percent gain accrued by the hedge fund activity? That's going to be paid by you, even though you never sold a share.
I guess I'll have to agree with the headlines—that's certainly an exciting feature. I suppose getting a root canal without the gas is “exciting” too.
ETFs treat all investors fairly. PHYS not so much.