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Hasty decisions may cost more than higher taxes

With all the ominous talk of tax increases and a "fiscal cliff" if President Obama and congressional leaders can't agree on a plan to avert automatic tax increases on Dec. 31, some investors may be tempted to act soon to take advantage of the current tax rates.

But financial advisers say that in their rush to doing something this year, investors may end up with regrets.

The taxes the wealthy worry most about are an increase in the capital gains rate to 20 percent from 15 percent, which would affect investments like stocks and second homes; an increase in the 15 percent tax on dividends; and a limitation on deductions, which would effectively increase the tax bill.

In addition, the health care law sets a 3.8 percent Medicare tax on investment income for individuals with more than $200,000 in annual income (and couples with more than $250,000).

Here is a look at some areas where decisions based solely on taxes could be ill advised.

Appreciated stock: Many people have large holdings in a single stock, often the result of working for a company for many years. And the stock may have appreciated significantly over that time. But if they are selling now solely for tax reasons, advisers say they shouldn't. The stock may continue to do well and more than compensate for increased capital gains.

But there is an upside to an increase in the capital gains rate: wealthier clients may finally be pushed to diversify their holdings.

Still, selling stock now may make sense when it is in the form of stock options set to expire early next year.

MUNICIPAL BONDS: Bonds sold to finance state and local government projects are tax-free now and will be tax-free next year. But advisers fear that individuals just above the $200,000 threshold will try to offset a tax increase by moving more of their investments into municipal bonds.

Beth Gamel, a certified public accountant, imagined a case where people in higher tax brackets, thinking they were acting rationally, sold stocks this year to take advantage of the lower capital gains rates and then, to avoid higher taxes next year, put all or some of that money into municipal bonds. Maybe they outsmart the tax man, but they do so at risk to their retirement.

"It will be very difficult for them to reach their long-term goals," she said, "because the yield on muni bonds is lower than stocks over time."

REAL ESTATE: Advisers are concerned that people will consider selling their home for fear that the appreciation on it will be more heavily taxed next year. Melissa Labant of the American Institute of Certified Public Accountants said that most home sales are never taxed because the first $500,000 of appreciation was exempt for a couple. Even if you are subject to capital gains tax, it is only on the amount above the exemption level.

INSURANCE TRICKS:Annuities are another area where people might rush in to avoid taxes. As with any insurance product, annuities get preferential tax treatment.

"I'm concerned that aggressive insurance people are going to see this as a time to sell annuities," Gamel said. "Annuities are among the most complex investment products there are. If we only have between now and Dec. 31, we don't have enough time to assess them."

SIMPLER SOLUTIONS:Andrew Ahrens, of Ahrens Investment Partners said he was telling clients that whatever happened next year could be reversed in two years with the next Congress, or in four with the next president.

Investors have an easier option. They can move assets that are likely to be taxed at a higher rate into retirement accounts and defer the tax, and put assets they don't plan to sell into taxable accounts.

Hasty decisions may cost more than higher taxes 12/02/12 [Last modified: Sunday, December 2, 2012 3:30am]
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