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Homemad moneyTax strategy could drive you into poor house

Tax strategy could drive you into poor house

(Click here for video linked to a searchable transcript of this Mad Money segment)

If you're an individual investor holding a portfolio of diversified stocks, chances are you've run into this issue before.

That is, you've bought and are now holding a stock that has appreciated significantly and you can't decide whether you should take profits and pay short-term capital gains tax or hold the stock and cash out after a year, when you're eligible for long-term capital gains tax.

The difference is significant.

"A short-term capital gain gets taxed at the ordinary income tax rate, which can be as high as 39.6%," explained Jim Cramer. By contrast, "the long-term capital gains rate is just 15% for most people, although if you're in one of the higher tax brackets, that rate becomes 20% and even 23.8% in certain circumstances.

Clearly, you could save a bundle if you simply hold the stock for more than a year. Should you do it?

Dominik Pabis | Getty Images

Although there are select circumstances when Cramer thinks the strategy makes sense, by and large, he wouldn't do it.

"Largely, you should never keep holding a stock just so you can avoid paying the higher short-term capital gains rate," the "Mad Money" host said.

Cramer advocates active money management and that involves revisiting your thesis for holding the stock on a regular basis. If, for some reason, that thesis has eroded, Cramer says you're much better off selling, then waiting to try and beat the tax man.

"Just think about it like this, okay? Imagine you owned all of those biotechs and cloud based software as service stocks that were red hot in 2013," he said. "Say you owned them for the last nine months of last year, right? And let's say you decided, 'these gains are so huge, I don't want to have to pay the tax man that horrible short-term capital gains rate. Instead, if I just hold them for three months longer so that the holding period is over year, I'll be in the clear and my tax bill on these holdings will be nearly cut in half thanks to the wonders of the long-term capital gains rate.'"

Had you followed that strategy, your gains would have evaporated at a breakneck pace. And, depending on the specific stocks, you may have lost your gains all together and ended in the red!

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Nobody likes paying taxes, Cramer understands that. "But whether you like it or not the government is going to take its cut. That's just how it works," he said.

And trying to game the government, can cost you much more than its worth.

Therefore, broadly, Cramer says follow this simple rule: Don't let tax considerations drive your investment decisions. If you do, it could drive you right into the poor house.

Call Cramer: 1-800-743-CNBC

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