5 Myths About Capital-Gains Tax in 2014

Sally Herigstad  for The Motley Fool writes: Financial myths can be very costly. That's never more true than when it comes to myths about capital gains -- especially given the new, higher rates for capital gains tax in 2014. Check out these five common myths.

Myth No. 1: Capital gains from mutual funds and REITs aren't taxable until I sell.If you own mutual fund or REIT shares in an account that is not tax-deferred, you can have a taxable capital gain even if you don't sell a thing. Mutual funds and REITs report your share of any gain on Form 1099-DIV, which they send to you and to the IRS.

Myth No. 2: I only have to hold on to an asset for one year before I sell it and have a long-term capital gain.That's "more than one year" in IRS speak -- in other words, one year and one day. Selling in too big of a hurry can cost you. If you hold the asset for one year or less, you have a short-term gain instead of a long-term one. You'll pay ordinary income-tax rates on your gain.

Myth No. 3: I don't have to worry about the new higher capital-gains bracket because I'm not rich.If you sell a lot of assets in one banner year, then, as far as the IRS is concerned, you're rich. Expect to pay up to 23.8% total tax on capital gains, counting the 3.8% additional tax on investment.

Prior to 2013, the highest long-term capital-gains tax rate was 15%. Now, there's a new 20% tax rate. It applies to your capital gains if you're in the new 39.6% income tax bracket. In other words, you may be taxed at a higher rate if your 2014 taxable income is more than $406,750 ($457,600 if you file jointly, $432,200 if head of household, or $228,800 if married filing separately).

Even if you're not rich enough to have to worry about the higher capital-gains tax rate, you could still owe the additional 3.8% tax on net investment income.

You can bump into the additional 3.8% tax if your modified adjusted gross income, or MAGI, is $200,000 or more ($250,000 if filing jointly, or $125,000 if married filing separately). MAGI for this purpose is your adjusted gross income on your Form 1040, reduced by investment interest expenses, advisory and brokerage fees, rental and royalty expenses, and state and local income taxes that you can allocate to your investment income.

Myth No. 4: There's nothing I can do to avoid the new capital-gains tax.Oh, yes there is!

Your tax bracket in the year you sell a capital asset, for example, has never been more important. If you can wait to sell an asset in an off year -- perhaps when you worked less than a full year or after you retire -- then your capital-gains tax rate could be 15%, 10%, or even 0% -- not the dreaded 23.8% you could pay in a good year.

Other tactics:

• Try selling some shares of a winning stock each year to avoid bumping your income into a higher tax bracket in one year.
• Unload loser stocks in the same year you cash in winners to offset your gains.
• If you make charitable donations, consider donating stock to charity instead of cash. You get a tax deduction for the amount it's worth now, and you don't pay tax on the amount it has gone up in value since you bought it.
• Sell real estate on an installment sale. You can spread the gain out over years, avoiding a big spike in income.

Myth No. 5: Minimizing capital-gains tax should be a primary focus of my investments.The primary purpose of investing is to make money. Anybody can tell you how to pay little or no taxes by not making money, or by losing money and taking a celebratory tax break.

For example, don't hang on to investments that are past their prime to avoid paying capital-gains tax -- not even with the new 20% tax bracket and added investment tax. Consider capital-gains taxes when you make investing decisions, but never let tax planning overrule your good investing sense.

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