Article by David John Marotta from Forbes.com
The capital gains tax is economically senseless. The tax traps wealth in an investment vehicle requiring special techniques to free the capital without penalty.
Multiple ways are available to avoid the tax, but none are beneficial to the economy. Here are 14 of the loopholes the government’s gain tax unintentionally incentivizes.
1. Match losses. Investors can realize losses to offset and cancel their gains for a particular year. Savvy investors harvest capital losses as they occur and then use them on current and future taxes. Up to $3,000 of excess losses not used to cancel gains can offset ordinary income. The remainder of the loss can be stored and carried forward indefinitely.
This encourages investors to sell great investment vehicles during a temporary dip only to buy them back again 30 days later for a new cost basis.
2. Primary residence exclusion. Individuals can exclude up to $250,000 of capital gains from the sale of their primary residence (or $500,000 for a married couple).
Families who stay in the same home for decades suffer a tax that more mobile families avoid.
Smart homeowners who might move or need the capital move more frequently to avoid the tax. Needlessly selling and buying a home is the arduous cost to the economy.
3. Home renovation. Sharp real estate agents and home renovators make their under-market investment purchases their primary residence while they are fixing them up. They then flip the houses, selling for a better sales price but avoiding any tax on their gains via the primary residence exclusion.
This bizarre game of paperwork adds no real value to the economy. However, the flipped houses do add a lot of value to the neighborhood, town and economy. The capital gains tax is wrong to discourage such improvement efforts.
4. 1031 exchange. If you sell rental or investment property, you can avoid capital gains and depreciation recapture taxes by rolling the proceeds of your sale into a similar type of investment within 180 days. This like-kind exchange is called a 1031 exchange after the relevant section of the tax code. Although the rules are so complex that people have jobs that consist of nothing but 1013 exchanges, no one trying to avoid paying this capital gains tax fails. This piece of valueless paperwork does the trick.
5. Stock exchange. Stock investors with highly appreciated securities can also do a like-kind exchange. Certain services offer investors with one highly appreciated security a way to trade it for an equivalently valued but more diversified portfolio. This expensive service can help investors avoid paying even larger capital gains taxes. But it is an entire field invented by government taxation. If the capital gains tax didn’t exist, all of those valuable workers and capital could be allocated to more economically beneficial means.
6. Exchange-traded funds. ETFs use stock exchanges to avoid triggering capital gains taxes when stocks move in or out of the index on which the ETF is based. Stocks moving out of the index are exchanged for stocks moving into the index. Investor cost basis transfers to the new securities.