ETF Trends
ETF Trends

Commodity exchange traded funds surged over the last three months after a lackluster 2013. With commodity-related ETFs and exchange traded notes (ETNs) back in the limelight, it is important for investors to understand how these products operate and how the IRS taxes these investment vehicles.

Commodity ETFs and exchange traded notes have been among the best performers year-to-date, with the iPath Dow Jones-UBS Coffee Total Return Sub-Index ETN (NYSEArca: JO) rising 81.6% so far this year on the severe drought conditions in Brazil, the world’s top producer of coffee. [Coffee ETN Gets Hyper as Brazilian Crops Wither]

Additionally, the United States Natural Gas Fund (NYSEArca: UNG) is still up 18.2% year-to-date despite falling prices on warmer weather conditions. Natural gas surged to a 5-year high in February. [Nat Gas ETF Surged on Winter Conditions, But Warmer Weather Ahead]

While it may be fun to play these types of short-term market moves in the commodities market, investors will have to deal with the slightly different taxes associated with the investments.

Commodities ETFs and other funds that use futures contracts to gain exposure to a market are structured as limited partnerships. Consequently, investors may have to fill out a Schedule K-1 instead of Form 1099, and they may incur Unrelated Business Taxable Income (UBTI), which could be taxable in an IRA. However, most ETFs provide K-1s in a timely manner and typically do not generate UBTIs.

Futures-backed ETFs, unlike equities and stock-based ETFs, are based on the so-called 60/40 rule, or 60% long-term gains at a maximum 23.8% rate and a 40% short-term gains at a maximum 43.4% rate, depending on the tax bracket, regardless of how long the investor holds the ETF.

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