8 ms·

Tax Planning 101: Buy, Borrow, Die

93 points by yonibot 5y ago

ailef 5y ago
Is it actually possible to borrow for so many times without ever returning it back or is this an hyperbole?
- helge9210 5y ago
  You pay back last year debt with the money you borrow this year.
  - ganzuul 5y ago
    VISAs business model in a nutshell, evidently.
  - Sam_Odio 5y ago
    Paying back debt requires income, which is taxed. In this example you continue to incur new debt, but at a rate not more than the growth rate of your assets.
  - weird-eye-issue 5y ago
    With a PAL you don't have to pay back the debt, just the interest, as long as the assets don't drop in value too much
- gnopgnip 5y ago
  Yes, you can take out a mortgage for instance
- Sam_Odio 5y ago
  In this example you will always have more in assets than you will borrow, so any new borrowing will be well collateralized. So yes, you can do this.
- MattGaiser 5y ago
  Certainly. This is basically a line of credit secured by your asset portfolio. As long as you keep that line of credit under your asset value and pay the interest, you can do this.
- akg_67 5y ago
  Yes, it is possible. Think of total assets as annuity, annual loan as payment from annuity, and interest as management fee charged by annuity administrator. Back of the napkin calculations: Total assets $100 million Annual Expenses as Annual Income Annual withdrawal = $4 million Assuming 40% tax, tax due = $1 million Asset liquidated = $5 million Remaining asset = $95 million End of Year asset @ 4% growth = 98.8 million Annual Expenses as Loan Annual withdrawal as loan = $4 million 1% interest on annual loan = $40,000 Asset liquidated to pay loan interest and taxes on liquidated assets = $60,000 Remaining assets = $99.940 million EOY asset = $103.937 million - $4 million
  - WalterBright 5y ago
    1% interest on annual loan? I'd like to know who your lender is! Inflation - ignored. What happens when your asset goes down in value - ignored.
    - novok 5y ago
      At IBKR, the margin loan rate is %1.1-%0.75 after the first $100k, and anyone can get that with no special negotiation effort. https://www.interactivebrokers.com/en/index.php?f=46376&p=m https://www.interactivebrokers.com/en/index.php?f=46376&p=m Now imagine you're a billionaire!
      - WalterBright 5y ago
        You're right. But I don't think that is likely to hold for very long. I've never seen interest rates this low in my life. Furthermore, when interest rates do go up, suddenly you're paying a lot of money for that large accumulated debt.
        cudgy 5y ago
        People have been saying “I’ve never seen interest rates this low in my life” for the last few decades. Also, much of the debt could be tied to long-term loans in which case the overall interest rate would not move much.
janandonly 5y ago
I would like to see the math on this same magic trick, but then applied to a normal Joe Average. My question is: how can I profit from these tax loopholes? How do I apply this if I only make, say, $35000 annually?
- MattGaiser 5y ago
  Income here is not relevant. What matters are assets you can borrow against. You could make 35,000 or 350,000, but it wouldn't be material. So the important question is how this could be applied with whatever your net worth in usually taxable assets is.
  - noduerme 5y ago
    I'm still confused about the mechanics of this as well. I suck at finance (Damnit Jim, I'm a coder, not a mortgage broker!) Like, if I were to get a reverse mortgage on my home equity let's say while rates are low. Take that and put it in the stock market, something that pays a high dividend. Makes sense that would be a win as long as the market doesn't crash[0]. But where's the tax advantage? If I ever want to spend that money I have to take it out and pay capital gains. The fact that the basis is adjusted when I die doesn't really help me. I guess if I had enough gains from stock to service the debt and declare a loss... is that the ticket? I really hate how I can write a genetic algo from scratch and then feel like a freakin 11 year old who just missed an easy layup every time I call my accountant. Reading a tax form makes my eyes gloss over faster than trying to look at someone's wordpress plugin. [0] which is why I haven't done this [edited for misplaced italics]
    - MattGaiser 5y ago
      > If I ever want to spend that money I have to take it out and pay capital gains. No. This is the trick. You can take money out of the asset tax free by borrowing against it. Say that you wanted to invest your home equity. You have two choices. You can sell the house and rent or borrow against the house. Imagine that you paid $0 for the house and can now sell it for $500,000. You have to pay tax on that, bringing it down to $425,000 in your pocket. You lose 15%. You put that 425K in the stock market and it gains 10% per year. After 10 years you have 1.1 million. Alternatively, you can just borrow 500,000 and put your house up as collateral to the bank you are borrowing from. You pay no tax on that 500K. Put that 500K in the market at the same 10%. You end up with 1.3 million in 10 years. The tax benefit is in avoiding the destruction of your initial capital by 15%. You effectively spent the money in our home, but one method makes you pay capital gains while another does not. You could spend your house equity on a boat in the same way. This example is very contrived and ignores things like the capital gains exemption on housing (and the fact that no house costs 0) and that you generally can't borrow 100% of house value (but you can with stocks as long as they are liquid).
TX0098812 5y ago
It's always upsetting when others have things.
- lovich 5y ago
  It’s always upsetting when free riders exist
  - rorykoehler 5y ago
    Capitalism is free riding by definition. Capital gets rewarded not work. It's even in the name.
    - fighterpilot 5y ago
      Capital is one of the factors of production, along with labor. They both get rewarded according to supply and demand.
      - rorykoehler 5y ago
        That's a bit disingenuous considering the scalability and concentration of capital compared to labour. Regardless your point doesn't refute mine. Supplying capital reqires zero personal effort.
        simonh 5y ago
        It’s entirely possible to close this loophole by taxing wealth/capital, and there are countries that do this, and they are still capitalist.
        fighterpilot 5y ago
        It's not disingenuous, it's simply a description of the market reality of both capital and labor and why they both have prices. Supplying capital is compensated by the market because it's a scarce factor of production. It is a scarce factor of production because (i) there are risks associated with its provision, (ii) there's an opportunity cost. Nobody would invest in a startup if there wasn't an expectation of an ROI. Because it's risky, that ROI is high. The ROI is high because the cost base is deflated by the market. This is a risk premium, and it's built into the cost base by supply and demand. This basic mechanism underpins all capital markets and is the reason capital markets function at all. Your statement about the scalability of capital is of course true. Capital offers the owner intense amounts of leverage and scale. The same can in general not be said about labor except in domains where that labor is scaled by technology (e.g. dev), media (e.g. instagram influencer), or being in a managerial position (e.g. decisions impact 1000-person org), which probably covers about 2% of the workforce.
ipnon 5y ago
The rich are characterized as inheeritors but most rich Americans got that way from business.
- concordDance 5y ago
  Most of the richest did, but is this true of those in the 10 million to 1 billion range?
  - novok 5y ago
    %80 of the american wealthy are first generation.
    - MagnumOpus 5y ago
      No source, and a very unlikely assertion.
      - novok 5y ago
        Please don't do a low effort 'no source' when a 1 minute google search shows you many, many sources: https://www.google.com/search?hl=en&q=how%20many%20americans%20are%20first%20generation%20millionaires%20percentage https://www.google.com/search?hl=en&q=how%20many%20americans... It's true. Maybe 50 years ago more wealth in america was inherited, now, not nearly as much. In "bastion of equality" western europe, the percentage of inherited wealthy is far higher!!
        xmprt 5y ago
        The article you're quoting mentions first generation millionaires, however, the commenter you replied to was talking about the 10MM to 1B range. 10MM is very different from 1MM. Almost every professional working as a doctor, lawyer, or programmer can make it to 1MM and in reality, 1MM is considered a very average amount to retire on these days so it's nothing special to be a millionaire. I'd like to see an analysis that shows the breakdown in different buckets. I suspect it's much easier today to be a first-gen millionaire in the 1 million dollar range but the higher you go, the more we'll see inherited wealth.
cannaceo 5y ago
What about the interest accruing on the debt? I didn’t see that accounted for.
- WalterBright 5y ago
  If you're paying 8% interest on the debt (Etrade charges a bit less than 8%) that can get out of hand quickly.
  - robotresearcher 5y ago
    That’s less than half the capital gains tax rate. You’d still come out ahead.
    - cudgy 5y ago
      Not necessarily…capital gains tax is only paid once while interest must be paid continuously.
      - robotresearcher 5y ago
        To live on these gains you’d need to sell periodically. And the taxes you didn’t pay are compounding in your investments to more than pay the interest rate forever.
- modeless 5y ago
  Don't forget that you get to keep your money invested, which means it keeps appreciating. As long as your investments outperform the interest rate, you come out ahead no matter how long you hold the loan. If you borrow at 3% and have the same amount of money invested and earning 10% nominal returns as the S&P 500 tends to do, you're still ahead 7% a year and can hold the loan forever without losing money. The biggest issue is if you keep taking loans every year, you might become over leveraged. Then if the market crashes you'll get margin called and lose everything. So this only works if your net worth is much higher than your annual spend, so your loans never reach more than around 30% of your net worth within your lifetime. The other issue of course is that there's no guarantee your investments will be able to outperform the interest rate, especially as it will almost certainly be a variable rate. But ignoring short term fluctuations, I think it's pretty unlikely that this would be a big problem over the long term.
WalterBright 5y ago
There's a limit on this. If you borrow against the capital appreciation, eventually your debt percentage will put you at risk of a margin call. If your assets drop in value such that the assets are less than the debt, you lose all your assets, and the portion of the debt not covered by your assets still sticks to you. I know people this has happened to. The trick relies on your assets always increasing in value, which is not what assets do in the real world.
- simonh 5y ago
  In practice the best strategy is not to borrow the maximum against the capital appreciation. You use this system to fund your day to day expenses as one part of an overall wealth management strategy.
  - WalterBright 5y ago
    You can keep under the maximum, and still get caught with a plunging asset value, leaving you with a negative net worth. I had a stock that dropped 90% in a period of a couple weeks. I didn't borrow against it, but I could have easily borrowed 40%, then when it dropped, I'd be holding the bag. The article's advice is glib and dangerous.
    - simonh 5y ago
      It’s not advice, it’s just explaining the strategy.
      - WalterBright 5y ago
        Ignoring the costs (of borrowing) and the risks (of winding up deep in debt) makes the article glib and dangerous.
- naturalauction 5y ago
  Are there actively managed ETFs with target dates? That way when you are still working you are purchasing shares of the ETF that are investing in a more risky strategy. However, by a certain date the ETF shifts to a much more conservative focus, allowing for you to borrow against said ETF without the risk of a margin call. Not an investment professional or even an amateur investor, just an idea I had so wouldn't be surprised if there is an issue in this.
novok 5y ago
It's funny, I saw a basic description of this mechanism on reddit a week ago and now it shows up here: https://old.reddit.com/r/fatFIRE/comments/o2w0wx/how_do_the_wealthy_live_off_loans/h28j4n0/ https://old.reddit.com/r/fatFIRE/comments/o2w0wx/how_do_the_...
- xvector 5y ago
  I am pretty sure that at least half of that sub is just somewhat financially literate people LARPing.
ozzyoli 5y ago
I have a friend who worked in the past five years for two tech companies that IPOd and has lots of vested stock. She wants to buy a house in San Francisco but doesn’t want to sell her stock to make the downpayment. She plans to use a collateral-loan offered by ETrade (who manages her employee stock plans).
- iancarroll 5y ago
  Would mortgage lenders allow this? I was under the impression that they trace the origin of the down payment for this reason (to prevent it from originating from another riskier loan), but I have no expertise here.
  - bombcar 5y ago
    One trick is to go to margin with your broker: 1. Transfer $500k in stock to TD Ameritrade (a stock transfer is not a sale/buy so it's not taxed) 2. Withdrawal $100k without selling anything (now you're $100k into margin. 3. Wait about 6 months. 4. Now you can use that as a down payment, and they'll just consider your margin balance as part of your overall debt picture.
WalterBright 5y ago
> into the extraordinary by withdrawing $300,000 in debt And gets to pay 8% interest on it (can't borrow money for free), which is $24,000/yr and compounds. Keep doing that every year, and this can get overwhelming. Be careful about careless articles like this one.
- curtisf 5y ago
  But with the example numbers in the post, your fund increases by $300,000 a year even after your "withdrawals". So, you're still netting $260,000 after the interest on your loans. And that growth compounds, too. (I'm not a multimillionaire, but I'm guessing you can get a bit better than 8% rate for a fully collateralized loan in exchange for your business) This strategy only works when your account grows by significant more than you need to spend, but that can happen with a relatively small fortune of a few million dollars.
  - WalterBright 5y ago
    The article fails to take these items into account. Omitting major costs is disingenuous at best.
- cornel_io 5y ago
  Someone rich borrowing against their own assets would never come close to 8%. Prime is 3.25% and AFR is even lower if they're able to borrow from "themselves" in some way (from an LLC, etc).
andi999 5y ago
So this relies on the loan rate to be not significantly higher than the appreciation of your assets?
- deleted 5y ago
  [deleted]
curtisf 5y ago
So, viewing such a thing being possible as a problem, what kind of "fix" to the tax rules is best? Prioritize taxes on spending instead of income? Sales taxes are usually regressive (people with less wealth/income spend a larger proportion of their wealth/income each year, AND they tend to spend it less on things that aren't sales-taxed like real estate, services, financial instruments, travel abroad, political lobbying). Spending also tends to be more sensitive to economic downturns than income, tightening government revenue when it often is needed the most. Maybe a separate expenditure tax that only applies to spending significantly more than you earn (and so is only collected from the wealthy)? Maybe something like... treating unrealized gains as realized when taking out debt? The problem is that if you have a $1 million trust that appreciates $40,000/yr, you "have" that money, but to actually _have_ that money costs you a taxation event, yet lenders don't really care about the difference between "having" and _having_ when there's so much extra collateral.
- noduerme 5y ago
  What about taxing lenders when they take loans against non physical collateral? i.e. something that's not a house, car or otherwise utilitarian infrastructure. Let them pass the tax on in rate hikes until it equals the capital gains tax. Just a spitball idea.
- novok 5y ago
  They could... charge the cap gains tax to the estate, getting rid of a big point of the strategy? The estate not having to pay cap gains on their gains is the big kicker and essentially arbitrary. If the person 1 month before they died sold a bunch of wealth to settle all of their debts, they would pay cap gains tax. But after their death, you do the same thing with their estate and they dont pay cap gains tax from gains before their death? It's a bit absurd.
  - fighterpilot 5y ago
    They should not charge cap gains on the estate, since that'll force sales of illiquid assets which is not good. They just have to not allow the resetting of the cost basis of the assets. It's a very simple fix.
ryandrake 5y ago
> The appreciated assets are now at a stepped-up basis, washing away the unrealized gains. They are then sold, without any built-in taxes I don't understand how this part works. Your estate has to pay off the accumulated debt before distributing the rest to your heirs. To do this, the estate must sell the underlying assets, which will realize gains. Those gains are subject to CG tax. What is this "stepped-up basis" wizardry? Does the cost basis of your assets reset to their market value the day you die?
- ctchocula 5y ago
  All assets within estate tax exemption limit $11.5M ($23M for married) receive a step-up basis on death. This means that cost basis resets to market value on the day you die, and your heirs can sell at market price the amount of money required to pay off the accumulated debt and start the cycle anew. It's a bit similar to tax gain harvesting, which is when if you live in a no state income tax state and anticipate making very little income this year, but have some appreciated stocks, what you can do is harvest the tax gains by selling the stocks in order to reset to the higher cost basis and immediately buying them back. Since you have little income, you can get away paying $0 tax until $38.6k ($77.2k if married).
  - WalterBright 5y ago
    > and immediately buying them back That's called a wash sale and the IRS is going to have a word with you about it. If you're going to do these things, I recommend getting some advice from a tax accountant.
    - novok 5y ago
      You buy an equivalent ETF. So sell your VTI and buy SCHB. It's a different stock ticker!
      - ryandrake 5y ago
        Wash sale rule applies to identical or "Substantially Identical" securities [1]. IRS is a bit vague in its definition, and you may have to argue that the new security is not Substantially Identical. Your example are two different indexes and two different companies, so it might be fine. 1: https://www.investopedia.com/terms/s/substantiallyidenticalsecurity.asp https://www.investopedia.com/terms/s/substantiallyidenticals...
bumbada 5y ago
Ohh, that is amazing! So you become rich but never use your money and then become the richest guy in the cemetery. That kind of rich is not rich at all, just "paper rich". As entrepreneur myself, it is not that easy to become rich, it is not that easy to make consistently 3% over inflation(specially when official inflation is not real like has happened for the last 20 years) and it is not that easy not to pay taxes. On the contrary in places like most of Europe the tax system is Hell for entrepreneurs, the System taking from 50 to 70% of your income. In my life as entrepreneur I have seen many friends starting a business and losing 20.000-300.000 euros on their ideas before quitting and returning to their original jobs. In year 2021 with COVID I have seen people losing millions of dollars, their entire life's savings and business. The Government is giving them peanuts. If you want to be rich, become a banker or Politian and be close to the printing money machine. They are the main beneficiaries from inflation, they create it, and extract a 3-9% of the economy's absolute wealth every single year doing nothing.
- imtringued 5y ago
  It's always surprising that when the last 20 years have been accompanied by extremely low inflation that people come up with the idea that inflation is too high. It's easy to make money off speculation and bubbles because of low inflation. Is it really that difficult to understand? If inflation was really as high as people claim then being idle and rich would really suck, as you would have to run or invest into a business with actual revenue and profit, otherwise your stocks would tank like in the dot com bubble.

93 points by yonibot 5y ago

ailef 5y ago

Is it actually possible to borrow for so many times without ever returning it back or is this an hyperbole?

helge9210 5y ago
You pay back last year debt with the money you borrow this year.
- ganzuul 5y ago
  VISAs business model in a nutshell, evidently.
- Sam_Odio 5y ago
  Paying back debt requires income, which is taxed. In this example you continue to incur new debt, but at a rate not more than the growth rate of your assets.
- weird-eye-issue 5y ago
  With a PAL you don't have to pay back the debt, just the interest, as long as the assets don't drop in value too much
gnopgnip 5y ago
Yes, you can take out a mortgage for instance
Sam_Odio 5y ago
In this example you will always have more in assets than you will borrow, so any new borrowing will be well collateralized. So yes, you can do this.
MattGaiser 5y ago
Certainly. This is basically a line of credit secured by your asset portfolio. As long as you keep that line of credit under your asset value and pay the interest, you can do this.
akg_67 5y ago
Yes, it is possible. Think of total assets as annuity, annual loan as payment from annuity, and interest as management fee charged by annuity administrator. Back of the napkin calculations: Total assets $100 million Annual Expenses as Annual Income Annual withdrawal = $4 million Assuming 40% tax, tax due = $1 million Asset liquidated = $5 million Remaining asset = $95 million End of Year asset @ 4% growth = 98.8 million Annual Expenses as Loan Annual withdrawal as loan = $4 million 1% interest on annual loan = $40,000 Asset liquidated to pay loan interest and taxes on liquidated assets = $60,000 Remaining assets = $99.940 million EOY asset = $103.937 million - $4 million
- WalterBright 5y ago
  1% interest on annual loan? I'd like to know who your lender is! Inflation - ignored. What happens when your asset goes down in value - ignored.
  - novok 5y ago
    At IBKR, the margin loan rate is %1.1-%0.75 after the first $100k, and anyone can get that with no special negotiation effort. https://www.interactivebrokers.com/en/index.php?f=46376&p=m https://www.interactivebrokers.com/en/index.php?f=46376&p=m Now imagine you're a billionaire!
    - WalterBright 5y ago
      You're right. But I don't think that is likely to hold for very long. I've never seen interest rates this low in my life. Furthermore, when interest rates do go up, suddenly you're paying a lot of money for that large accumulated debt.
      - cudgy 5y ago
        People have been saying “I’ve never seen interest rates this low in my life” for the last few decades. Also, much of the debt could be tied to long-term loans in which case the overall interest rate would not move much.

janandonly 5y ago

I would like to see the math on this same magic trick, but then applied to a normal Joe Average. My question is: how can I profit from these tax loopholes? How do I apply this if I only make, say, $35000 annually?

MattGaiser 5y ago
Income here is not relevant. What matters are assets you can borrow against. You could make 35,000 or 350,000, but it wouldn't be material. So the important question is how this could be applied with whatever your net worth in usually taxable assets is.
- noduerme 5y ago
  I'm still confused about the mechanics of this as well. I suck at finance (Damnit Jim, I'm a coder, not a mortgage broker!) Like, if I were to get a reverse mortgage on my home equity let's say while rates are low. Take that and put it in the stock market, something that pays a high dividend. Makes sense that would be a win as long as the market doesn't crash[0]. But where's the tax advantage? If I ever want to spend that money I have to take it out and pay capital gains. The fact that the basis is adjusted when I die doesn't really help me. I guess if I had enough gains from stock to service the debt and declare a loss... is that the ticket? I really hate how I can write a genetic algo from scratch and then feel like a freakin 11 year old who just missed an easy layup every time I call my accountant. Reading a tax form makes my eyes gloss over faster than trying to look at someone's wordpress plugin. [0] which is why I haven't done this [edited for misplaced italics]
  - MattGaiser 5y ago
    > If I ever want to spend that money I have to take it out and pay capital gains. No. This is the trick. You can take money out of the asset tax free by borrowing against it. Say that you wanted to invest your home equity. You have two choices. You can sell the house and rent or borrow against the house. Imagine that you paid $0 for the house and can now sell it for $500,000. You have to pay tax on that, bringing it down to $425,000 in your pocket. You lose 15%. You put that 425K in the stock market and it gains 10% per year. After 10 years you have 1.1 million. Alternatively, you can just borrow 500,000 and put your house up as collateral to the bank you are borrowing from. You pay no tax on that 500K. Put that 500K in the market at the same 10%. You end up with 1.3 million in 10 years. The tax benefit is in avoiding the destruction of your initial capital by 15%. You effectively spent the money in our home, but one method makes you pay capital gains while another does not. You could spend your house equity on a boat in the same way. This example is very contrived and ignores things like the capital gains exemption on housing (and the fact that no house costs 0) and that you generally can't borrow 100% of house value (but you can with stocks as long as they are liquid).

TX0098812 5y ago

It's always upsetting when others have things.

lovich 5y ago
It’s always upsetting when free riders exist
- rorykoehler 5y ago
  Capitalism is free riding by definition. Capital gets rewarded not work. It's even in the name.
  - fighterpilot 5y ago
    Capital is one of the factors of production, along with labor. They both get rewarded according to supply and demand.
    - rorykoehler 5y ago
      That's a bit disingenuous considering the scalability and concentration of capital compared to labour. Regardless your point doesn't refute mine. Supplying capital reqires zero personal effort.
      - simonh 5y ago
        It’s entirely possible to close this loophole by taxing wealth/capital, and there are countries that do this, and they are still capitalist.
      - fighterpilot 5y ago
        It's not disingenuous, it's simply a description of the market reality of both capital and labor and why they both have prices. Supplying capital is compensated by the market because it's a scarce factor of production. It is a scarce factor of production because (i) there are risks associated with its provision, (ii) there's an opportunity cost. Nobody would invest in a startup if there wasn't an expectation of an ROI. Because it's risky, that ROI is high. The ROI is high because the cost base is deflated by the market. This is a risk premium, and it's built into the cost base by supply and demand. This basic mechanism underpins all capital markets and is the reason capital markets function at all. Your statement about the scalability of capital is of course true. Capital offers the owner intense amounts of leverage and scale. The same can in general not be said about labor except in domains where that labor is scaled by technology (e.g. dev), media (e.g. instagram influencer), or being in a managerial position (e.g. decisions impact 1000-person org), which probably covers about 2% of the workforce.

ipnon 5y ago

The rich are characterized as inheeritors but most rich Americans got that way from business.

concordDance 5y ago
Most of the richest did, but is this true of those in the 10 million to 1 billion range?
- novok 5y ago
  %80 of the american wealthy are first generation.
  - MagnumOpus 5y ago
    No source, and a very unlikely assertion.
    - novok 5y ago
      Please don't do a low effort 'no source' when a 1 minute google search shows you many, many sources: https://www.google.com/search?hl=en&q=how%20many%20americans%20are%20first%20generation%20millionaires%20percentage https://www.google.com/search?hl=en&q=how%20many%20americans... It's true. Maybe 50 years ago more wealth in america was inherited, now, not nearly as much. In "bastion of equality" western europe, the percentage of inherited wealthy is far higher!!
      - xmprt 5y ago
        The article you're quoting mentions first generation millionaires, however, the commenter you replied to was talking about the 10MM to 1B range. 10MM is very different from 1MM. Almost every professional working as a doctor, lawyer, or programmer can make it to 1MM and in reality, 1MM is considered a very average amount to retire on these days so it's nothing special to be a millionaire. I'd like to see an analysis that shows the breakdown in different buckets. I suspect it's much easier today to be a first-gen millionaire in the 1 million dollar range but the higher you go, the more we'll see inherited wealth.

cannaceo 5y ago

What about the interest accruing on the debt? I didn’t see that accounted for.

WalterBright 5y ago
If you're paying 8% interest on the debt (Etrade charges a bit less than 8%) that can get out of hand quickly.
- robotresearcher 5y ago
  That’s less than half the capital gains tax rate. You’d still come out ahead.
  - cudgy 5y ago
    Not necessarily…capital gains tax is only paid once while interest must be paid continuously.
    - robotresearcher 5y ago
      To live on these gains you’d need to sell periodically. And the taxes you didn’t pay are compounding in your investments to more than pay the interest rate forever.
modeless 5y ago
Don't forget that you get to keep your money invested, which means it keeps appreciating. As long as your investments outperform the interest rate, you come out ahead no matter how long you hold the loan. If you borrow at 3% and have the same amount of money invested and earning 10% nominal returns as the S&P 500 tends to do, you're still ahead 7% a year and can hold the loan forever without losing money. The biggest issue is if you keep taking loans every year, you might become over leveraged. Then if the market crashes you'll get margin called and lose everything. So this only works if your net worth is much higher than your annual spend, so your loans never reach more than around 30% of your net worth within your lifetime. The other issue of course is that there's no guarantee your investments will be able to outperform the interest rate, especially as it will almost certainly be a variable rate. But ignoring short term fluctuations, I think it's pretty unlikely that this would be a big problem over the long term.

WalterBright 5y ago

There's a limit on this. If you borrow against the capital appreciation, eventually your debt percentage will put you at risk of a margin call. If your assets drop in value such that the assets are less than the debt, you lose all your assets, and the portion of the debt not covered by your assets still sticks to you. I know people this has happened to. The trick relies on your assets always increasing in value, which is not what assets do in the real world.

simonh 5y ago
In practice the best strategy is not to borrow the maximum against the capital appreciation. You use this system to fund your day to day expenses as one part of an overall wealth management strategy.
- WalterBright 5y ago
  You can keep under the maximum, and still get caught with a plunging asset value, leaving you with a negative net worth. I had a stock that dropped 90% in a period of a couple weeks. I didn't borrow against it, but I could have easily borrowed 40%, then when it dropped, I'd be holding the bag. The article's advice is glib and dangerous.
  - simonh 5y ago
    It’s not advice, it’s just explaining the strategy.
    - WalterBright 5y ago
      Ignoring the costs (of borrowing) and the risks (of winding up deep in debt) makes the article glib and dangerous.
naturalauction 5y ago
Are there actively managed ETFs with target dates? That way when you are still working you are purchasing shares of the ETF that are investing in a more risky strategy. However, by a certain date the ETF shifts to a much more conservative focus, allowing for you to borrow against said ETF without the risk of a margin call. Not an investment professional or even an amateur investor, just an idea I had so wouldn't be surprised if there is an issue in this.

novok 5y ago

It's funny, I saw a basic description of this mechanism on reddit a week ago and now it shows up here: https://old.reddit.com/r/fatFIRE/comments/o2w0wx/how_do_the_wealthy_live_off_loans/h28j4n0/ https://old.reddit.com/r/fatFIRE/comments/o2w0wx/how_do_the_...

xvector 5y ago
I am pretty sure that at least half of that sub is just somewhat financially literate people LARPing.

ozzyoli 5y ago

I have a friend who worked in the past five years for two tech companies that IPOd and has lots of vested stock. She wants to buy a house in San Francisco but doesn’t want to sell her stock to make the downpayment. She plans to use a collateral-loan offered by ETrade (who manages her employee stock plans).

iancarroll 5y ago
Would mortgage lenders allow this? I was under the impression that they trace the origin of the down payment for this reason (to prevent it from originating from another riskier loan), but I have no expertise here.
- bombcar 5y ago
  One trick is to go to margin with your broker: 1. Transfer $500k in stock to TD Ameritrade (a stock transfer is not a sale/buy so it's not taxed) 2. Withdrawal $100k without selling anything (now you're $100k into margin. 3. Wait about 6 months. 4. Now you can use that as a down payment, and they'll just consider your margin balance as part of your overall debt picture.

WalterBright 5y ago

> into the extraordinary by withdrawing $300,000 in debt And gets to pay 8% interest on it (can't borrow money for free), which is $24,000/yr and compounds. Keep doing that every year, and this can get overwhelming. Be careful about careless articles like this one.

curtisf 5y ago
But with the example numbers in the post, your fund increases by $300,000 a year even after your "withdrawals". So, you're still netting $260,000 after the interest on your loans. And that growth compounds, too. (I'm not a multimillionaire, but I'm guessing you can get a bit better than 8% rate for a fully collateralized loan in exchange for your business) This strategy only works when your account grows by significant more than you need to spend, but that can happen with a relatively small fortune of a few million dollars.
- WalterBright 5y ago
  The article fails to take these items into account. Omitting major costs is disingenuous at best.
cornel_io 5y ago
Someone rich borrowing against their own assets would never come close to 8%. Prime is 3.25% and AFR is even lower if they're able to borrow from "themselves" in some way (from an LLC, etc).

andi999 5y ago

So this relies on the loan rate to be not significantly higher than the appreciation of your assets?

deleted 5y ago
[deleted]

curtisf 5y ago

So, viewing such a thing being possible as a problem, what kind of "fix" to the tax rules is best? Prioritize taxes on spending instead of income? Sales taxes are usually regressive (people with less wealth/income spend a larger proportion of their wealth/income each year, AND they tend to spend it less on things that aren't sales-taxed like real estate, services, financial instruments, travel abroad, political lobbying). Spending also tends to be more sensitive to economic downturns than income, tightening government revenue when it often is needed the most. Maybe a separate expenditure tax that only applies to spending significantly more than you earn (and so is only collected from the wealthy)? Maybe something like... treating unrealized gains as realized when taking out debt? The problem is that if you have a $1 million trust that appreciates $40,000/yr, you "have" that money, but to actually _have_ that money costs you a taxation event, yet lenders don't really care about the difference between "having" and _having_ when there's so much extra collateral.

noduerme 5y ago
What about taxing lenders when they take loans against non physical collateral? i.e. something that's not a house, car or otherwise utilitarian infrastructure. Let them pass the tax on in rate hikes until it equals the capital gains tax. Just a spitball idea.
novok 5y ago
They could... charge the cap gains tax to the estate, getting rid of a big point of the strategy? The estate not having to pay cap gains on their gains is the big kicker and essentially arbitrary. If the person 1 month before they died sold a bunch of wealth to settle all of their debts, they would pay cap gains tax. But after their death, you do the same thing with their estate and they dont pay cap gains tax from gains before their death? It's a bit absurd.
- fighterpilot 5y ago
  They should not charge cap gains on the estate, since that'll force sales of illiquid assets which is not good. They just have to not allow the resetting of the cost basis of the assets. It's a very simple fix.

ryandrake 5y ago

> The appreciated assets are now at a stepped-up basis, washing away the unrealized gains. They are then sold, without any built-in taxes I don't understand how this part works. Your estate has to pay off the accumulated debt before distributing the rest to your heirs. To do this, the estate must sell the underlying assets, which will realize gains. Those gains are subject to CG tax. What is this "stepped-up basis" wizardry? Does the cost basis of your assets reset to their market value the day you die?

ctchocula 5y ago
All assets within estate tax exemption limit $11.5M ($23M for married) receive a step-up basis on death. This means that cost basis resets to market value on the day you die, and your heirs can sell at market price the amount of money required to pay off the accumulated debt and start the cycle anew. It's a bit similar to tax gain harvesting, which is when if you live in a no state income tax state and anticipate making very little income this year, but have some appreciated stocks, what you can do is harvest the tax gains by selling the stocks in order to reset to the higher cost basis and immediately buying them back. Since you have little income, you can get away paying $0 tax until $38.6k ($77.2k if married).
- WalterBright 5y ago
  > and immediately buying them back That's called a wash sale and the IRS is going to have a word with you about it. If you're going to do these things, I recommend getting some advice from a tax accountant.
  - novok 5y ago
    You buy an equivalent ETF. So sell your VTI and buy SCHB. It's a different stock ticker!
    - ryandrake 5y ago
      Wash sale rule applies to identical or "Substantially Identical" securities [1]. IRS is a bit vague in its definition, and you may have to argue that the new security is not Substantially Identical. Your example are two different indexes and two different companies, so it might be fine. 1: https://www.investopedia.com/terms/s/substantiallyidenticalsecurity.asp https://www.investopedia.com/terms/s/substantiallyidenticals...

bumbada 5y ago

Ohh, that is amazing! So you become rich but never use your money and then become the richest guy in the cemetery. That kind of rich is not rich at all, just "paper rich". As entrepreneur myself, it is not that easy to become rich, it is not that easy to make consistently 3% over inflation(specially when official inflation is not real like has happened for the last 20 years) and it is not that easy not to pay taxes. On the contrary in places like most of Europe the tax system is Hell for entrepreneurs, the System taking from 50 to 70% of your income. In my life as entrepreneur I have seen many friends starting a business and losing 20.000-300.000 euros on their ideas before quitting and returning to their original jobs. In year 2021 with COVID I have seen people losing millions of dollars, their entire life's savings and business. The Government is giving them peanuts. If you want to be rich, become a banker or Politian and be close to the printing money machine. They are the main beneficiaries from inflation, they create it, and extract a 3-9% of the economy's absolute wealth every single year doing nothing.

imtringued 5y ago
It's always surprising that when the last 20 years have been accompanied by extremely low inflation that people come up with the idea that inflation is too high. It's easy to make money off speculation and bubbles because of low inflation. Is it really that difficult to understand? If inflation was really as high as people claim then being idle and rich would really suck, as you would have to run or invest into a business with actual revenue and profit, otherwise your stocks would tank like in the dot com bubble.