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.

7. Traditional IRA and 401k. If you are in the higher tax brackets during your working career, you can benefit from contributing to a traditional IRA or 401k. This both reduces your income while you are in the higher brackets and eliminates any capital gains as a result of trading in the account. Rebalancing by selling appreciated asset classes in a tax-deferred account avoids the capital gains tax normally associated with such trading. During the gap years, between retirement and age 70, withdrawals from these accounts could be made in the lower tax brackets.

8. Roth IRA and 401k. Traditional accounts can postpone taxes to a more favorable year, but Roth accounts can avoid them altogether. Having paid tax on deposits, a Roth account allows tax-free growth for the remainder of not only your life but also the lifetime of your heirs. Unless you are in the higher tax brackets and approaching the gap years, Roth accounts are usually an excellent tax strategy.

9. Health Savings Accounts. HSAs are one of the few accounts where you can receive a tax deduction for contributing to them, invest them and receive tax free growth and then not pay any taxes as long as you use withdrawals for qualified health expenses. Investing your HSA account to receive tax free growth is another way to avoid paying the capital gains tax.

However, all of the tax-advantaged accounts just described are further paperwork at the end of the day. No real economic value is gained from this complicated shuffle of assets, even though you clearly benefit by retaining more of your assets.

10. Give stocks to family members. If you are facing a high capital gains rate, you can give your highly appreciated securities to family members who are in lower brackets. Those receiving the gift assume your cost basis for computing the gain but use their own tax rate.

11. Move to a lower tax bracket state. State taxes are added on to federal capital gains tax rates and vary depending on your location. California has the highest U.S. capital gains rate and the second highest internationally, with a top rate of 37.1%.

In the United States, nine states add nothing to the federal top rate of 23.8%: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming. No national value is added by moving, although individuals can certainly gain from living in a state that taxes their particular assets favorably.

12. Gift to charity. Instead of giving cash to the charities you support, you can give appreciated stock. You receive the same tax deduction. When the charity sells the stock, it is not subject to any capital gains tax. The cash you would have given is the same amount you would have had for selling the stock and paying no capital gains yourself.

13. Buy and hold. Many investors buy good index funds that never need to be sold. Even if you rebalance regularly, rebalancing can often be accomplished by using the interest and dividends paid to purchase whichever investments need to be bolstered. The downside is that your capital is locked inside the investment vehicles and not free to be used for greater economic gain.

14. Wait until you die. Most people die holding highly appreciated investments. When you die, your heirs get a step up in cost basis and therefore pay no capital gains tax on a lifetime of growth.

Because most savvy individuals can decide the timing and amount of capital gains they choose to realize each year, the capital gains tax is considered very elastic. The amount of capital gains realized depends heavily on the favorability of the capital gains tax rate.

As a result, over half of capital gains are never taxed. They are avoided completely. But the effort of avoiding the tax causes capital to be allocated inefficiently in the meantime.

The tax punishes entrepreneurship. Were the capital gains tax abolished entirely, some of the lost tax would be regained through economic expansion and more efficient and liquid capital markets. Conversely, since capital gains taxes have been raised, the slowing of economic growth could reduce tax revenue by more than the additional tax collected.

The optimum capital gains tax rate is zero. If it was zero for everyone, all these shenanigans to avoid the tax could be ignored.

Photo by Courtney Carmody used here under Flickr Creative Commons.