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One of the primary mechanisms for tax avoidance is taking out loans against appreciated capital assets to avoid realizing capital gains. What's stopping the av
by fairity 5y ago
One of the primary mechanisms for tax avoidance is taking out loans against appreciated capital assets to avoid realizing capital gains.
What's stopping the average citizen from exploiting this tax avoidance strategy?
For example, every time I try to submit an order to sell stock that results in short-term capital gains, my broker should be asking me whether I want to take out a collateralized loan instead.
If there are loopholes in the tax system, they should be made readily accessible to all.
- ajaimk 5y agoYou can: https://www.schwab.com/pledged-asset-line https://www.schwab.com/pledged-asset-line https://www.wealthfront.com/portfolio-line-of-credit https://www.wealthfront.com/portfolio-line-of-credit And HELOCs are essentially the same for people who own a house but not stocks.
- fairity 5y agoGot it, but why don't brokers more aggressively push this program onto clients? It seems like a win-win. The debtor avoids the elevated short-term capital gains tax. The bank gets interest payments on a loan that has an almost 0 default rate due to the loan being fully collateralized.
- iooi 5y ago> It seems like a win-win. It's not a win-win, there's significant risk. > fully collateralized This is not true! The underlying asset fluctuates in value and is open to lowering significantly in value, leaving the bank holding the bag.
- ac29 5y ago> leaving the bank holding the bag You probably underestimate the ability of banks to evaluate risk. Yes, they absolutely could end up underwater on an asset backed loan, but you also shouldn't assume that you can take out $1 in loans on every $1 of stock. On Schwab's page, they say: "Schwab Bank, in its sole discretion, will determine what collateral is eligible collateral and the loan value of collateral". So, if you have some recently highly-appreciated shares of AMC for example, they might decide they are not eligible collateral, or only offer to lend you $1 for every $5 of stock.
- influx 5y agoLOL, yeah the banks have been so great at leverage in the past couple of decades in the USA that they have to get bailed out repeatedly.
- AdamN 5y agoDepends on what you spend the money on. If you take the margin and spend it on an asset, then you have the underlying stock as well as the asset to cover calls. Still requires correct thinking but the risk is mostly based on what you do with the loan.
- cj 5y ago> why don't brokers more aggressively push this program onto clients They do. Wealthfront (as just one example) features and advertises this prominently in their app. It's also very easy to do with Robinhood, simply withdraw cash using your margin. Interest rates are quite low. 2.5% with Robinhood, 3.65% with Wealthfront. There's a big "Borrow cash" button right when you open the Wealthfront app.
- relix 5y agoYou're basically describing a margin account. If you have a portfolio on a margin account at the broker, you can just withdraw money from it up to the amount that your margin allows. That automatically starts a loan for that amount, collateralised by your portfolio. The problem is that this is not nearly the same as selling stock and withdrawing the sales money, because you keep the risk that the stock will go down thus force liquidating your portfolio. You're conflating selling and borrowing, they're not identical except in these very vague tales about the ultra-rich.
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- ajb 5y ago"What's stopping the average citizen from exploiting this tax avoidance strategy?" Probably that the average citizen doesn't have capital gains.
- twinge 5y agoOnly 55% of Americans own stock: https://news.gallup.com/poll/266807/percentage-americans-owns-stock.aspx https://news.gallup.com/poll/266807/percentage-americans-own...
- iso1631 5y agomost of those will be in retirement plans which I assume aren't taxed?
- MR4D 5y ago> which I assume aren't taxed? It depends on which kind of retirement account. Might be in Roths and Roths-401Ks which are taxed when the money goes in (treated as regular income), or IRAs and regular 401Ks which are taxed as regular income when the money comes out.
- repiret 5y agoBut neither Roth nor Traditional 401k/403b/457/IRA are subject to capital gains tax.
- Nbox9 5y agoIf you are in the US you should brush up on your personal finances.
- iso1631 5y agoI'm not, maybe you should brush up on the rest of the world existing
- notahacker 5y ago
- tomp 5y agoCan you explain how this works, how it avoids tax? Taking a $100 loan still means you’ll need an income of $100 (plus interest) future income and tax paid on this income... If you’re gonna say “they benefit in the extra capital gains between now and when the loan is repaid” - no, that can’t be it, that’s exactly equivalent to taking a $100 loan and investing in stocks instead (i.e. leverage).
- jedberg 5y agoThe assumption is that you are using the money for an income generating activity like buying a rental property.
- mciancia 5y agoHm, but income from rental is also taxed, isn't it? If so, how does it help?
- jedberg 5y agoThe income from the rental is taxed, but slowly over decades. You don't have to take that entire tax hit in one year.
- alex_young 5y agoYou can also sell it and take the gains tax free in many cases.
- MR4D 5y agoShort of a 1031 exchange, I'm not sure how you would do that.
- alex_young 5y agoYou can sell a house every 2 years and write off up to $500k in capital gains as long as it’s been your primary residence for 2 of the last 5 years. Doesn’t need to be consecutive.
- fryry 5y agoAlso available in the UK, Interactive Brokers margin loan. The interest rate is 1-2% p.a.
- jedberg 5y agoMy Etrade account has that option. But I don't use it because it's risky. If you take out a loan collateralized by a stock, the stock could drop and you'd owe a lot of money. Selling the stock locks in the gain. Now, if you only need say 1/2 the value as cash and can absorb the risk of the stock going down, then it makes sense. Or if you want to "buy insurance" by taking out an opposite short position, that would also make sense. But that short position will cost you money too. So it's not as straightforward as "just take out a loan". You need a very good (and expensive) tax accountant to run the numbers and figure out the best strategy for your situation. Most people can't afford that.
- fairity 5y agoWhy isn't there an option to take out a loan where a repayment option is to transfer the capital asset (at whatever the value happens to be at the time of repayment)? I.e. I don't get why the risky part of this loan can't be mitigated by the bank taking on the risk and managing it separately. Surely, there would be investors willing to back these types of collateralized loans?
- jedberg 5y agoYou'd need a crazy high interest rate to account for market volatility. If the bank could make accurate predictions as to the future value of the stock, they would just invest in the stocks. Loans against other assets are much less risky, because they are backed by actual things. If the bank screws up in predicting the future value of a house, they can still own the actual house and land if you default. With stocks it would be far more risky because stocks are far more volatile than houses.
- fairity 5y agoHm, is it possible to define a range for "crazy high interest"? As the debtor, I'd be willing to pay up to the difference in long-term and short-term capital gains (~15%). I guess where I'm going with this is: I don't understand why the average person ever pays short-term capital gains tax.
- adolph 5y agoIf one’s broker had collateralized loans in their menu of options, what volume of gains are needed to overcome the initial setup costs of the loan?
- lumost 5y agoThe average citizen can't borrow to pay off debts indefinitely. At ~2% interest the billionaire can borrow against their assets and keep borrowing to pay off interest. The assets gain in value at 4-6% per year so they are actually coming out ahead and paying 0% tax. Even a middle class retiree typically needs to draw down their savings to pay expenses. Giving up 2% to avoid taxes wouldn't be viable. The bank would also observe that there is a higher risk that the retiree goes bust than a billionaire and not lend enough money for the scheme to be worthwhile.
- dillondoyle 5y agoor even at all! large amount of Americans don't even have access to banking. The loans they can get are insanely (i think disgustingly) predatory. payday loans with fees can ed up being like 664% APR!!!!! Your 500 loan becomes 2000 you have to pay back in a couple months, which you obviously can't.. https://www.cnbc.com/2021/02/16/map-shows-typical-payday-loan-rate-in-each-state.html https://www.cnbc.com/2021/02/16/map-shows-typical-payday-loa...
- Ericson2314 5y agoRight it's crucially important we leapfrog all this crypto and fintech nonsense by just doing "fed accounts for all" administered electronically and at the post office. Boring commercial banking should be utility, and any private sector offering will have to compete with a new non-grifter baseline.
- jjeaff 5y agoAnd 2% is really high. Billionaires are likely getting less than 1% interest rates. Big banks are willing to lose money even, just to court these billionaires.
- AnimalMuppet 5y agoUm, at various times I have had a home equity loan...
- MR4D 5y agoYour example of loans is tax deferral, not avoidance. As for your examples in general, those are really good. Collateralized loans on stock we usually call "margin loans" and are easy to get. Also, anyone in real estate will recognize the term "HELOC", where you can get a loan against the value of your home, presumably after its value has appreciated. I think both of those are fairly accessible, at least in the US.
- AdamN 5y agoFor the mega-rich it's tax avoidance. That money gets rolled into the estate or trust with the cost-basis resetting on death.
- tootie 5y agoThat's not a tax loophole though. You still have to pay back the loan with interest. And it has to be paid with cash from somewhere. People like Bezos do this primarily to retain their equity because it's worth more than money to them. It's their ownership stake. For others, they are just betting the assets will appreciate more than the cost of the interest. It's income optimization not tax avoidance. You can do the same thing with a HELOC. Otherwise you'd have to sell your house and pay cap gains then spend the net profit. I don't think a HELOC is tax dodge.
- jjeaff 5y agoHELOC definitely isn't a tax dodge because the first $250k-$500k of profit on the sale of your home is not taxable anyway. But there is something to be said about being able to defer taxes effectively forever. Only the ultra-wealthy are able to do this.
- tootie 5y agoThis doesn't defer taxes, it defers realizing profits. The loan payments have to be made with cash that came from some source which can likely be taxed. Anyone with assets can do this proportional to their assets. Admittedly most people don't have sufficient assets to make it worthwhile. Nor do they exercise the voting rights on stocks. But really any middle class investor with a nest egg could do it.
- WalterBright 5y ago> What's stopping the average citizen from exploiting this tax avoidance strategy? If your stocks go down, you still owe the full amount of the loan. If your stocks go to zero, you still owe the full amount of the loan.
- onlyrealcuzzo 5y agoI've been saying this for years. Low interest rates are like a triple handout to the extremely wealthy. 1) pump up asset prices. 2) lower the rate at which you can borrow against unrealized gains to make avoiding taxes more attractive. 3) people use this savings to buy more assets. Repeat step 1. Virtuous cycle. I can't go to a bank and get a loan against $1M in my 401k at 2% interest. But I know people with $50M+ that are doing this. It's absurd.