Traps to Avoid in Converting Unallocated to Allocated Metals

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In the last few months, I’ve received dozens of inquiries from readers who wish to convert their “unallocated” holdings of gold or precious metals to “allocated” form.

What’s the difference? “Allocated” storage means that a bank or warehouse has specific coins or bars that you own set aside. “Unallocated” storage means that you have an ownership interest in a precious metals pool. Because unallocated storage is less expensive, it’s the preferred storage option for many investors. On the other hand, because with allocated storage you own specific coins or bars, many investors prefer this option.

I’m not going to wade into the debate as to the merits of allocated verses unallocated storage. Both have their place. Rather, I’ll address what you need to consider if you plan to convert unallocated precious metals to allocated metals.

#1. Many if not most companies that offer unallocated storage for metals will treat the conversion of unallocated holdings for allocated holdings as a sale. For U.S. persons, that’s a taxable event at a top rate of 28%.

#2. If you take personal delivery of allocated metals from a facility classified as a “bonded warehouse,” when you sell the metals, the buyer may demand an assay. This can be an expensive process representing several percent of the metals’ value.

What’s the best way to deal with these issues? To avoid tax on the conversion of metals from unallocated to allocated form, consider a “1031 exchange.”

According to Section 1031(a)(1) of the U.S. Tax Code:

“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”

Section 1031 lets you defer paying federal capital gains taxes when you sell an investment property and buy another one of “like kind” through an approved exchange transaction. To have a fully deferred exchange, the property you acquire must be of equal or greater value to the property you sell.

Almost any like-kind investment property can be exchanged, including precious metals. In addition, the holdings you exchange in a 1031 transaction must either all be in the United States or all involve foreign properties. You can’t exchange a domestic property for a foreign one, or vice-versa.

The difficulty with a 1031 exchange for precious metals is finding what the IRS calls a qualified intermediary (QI); in effect, a “middleman” to handle the money. And even if you do find a QI willing to handle a conversion of unallocated to allocated metals, you need to make sure that the company storing your metals will go along.

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The following rules must also be followed:

  • The metals must be “like kind.” For instance, IRS has stated that the exchange of Mexican 50-peso gold coins for Austrian 100-corona gold coins qualified for a 1031 exchange. On the other hand, the exchange of bullion-type coins for numismatic coins didn’t qualify.
  • You must sign the exchange agreement with your QI before selling the unallocated metals.
  • Within 45 days after selling the unallocated metals, you must identify allocated metals you wish to purchase.
  • You have a maximum of 180 days to complete the sale.

What about avoiding an assay upon selling the metals? If you can avoid taking personal delivery, and keep the metals at all times in a bonded warehouse, you can generally avoid the need for an assay. If you do take personal delivery, make certain the metals come with a certificate of authentication from the refiner and (in the case of bars) are imprinted with the refiner’s serial number. These items give a prospective buyer assurance that the metals you’re selling are genuine.

Have you recently converted unallocated to allocated metals? Were you able to do so in a 1031 exchange? And if you eventually sold the metals delivered to you, did the buyer insist on an assay?

Please comment – I’d love to hear about your experiences.

Reprinted with permission from The Sovereign Society.

December 16, 2010