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I never understood the issue. You borrow money against your equity, but have to pay it back, with post tax dollars. Plus you pay interest on it anyway. So where

by bko 2y ago

I never understood the issue. You borrow money against your equity, but have to pay it back, with post tax dollars. Plus you pay interest on it anyway. So where it the loophole. Simplified example, I have $100 worth of stock, I borrow $10 and pay 10% interest. I eventually have to come up with the $10 to pay it back, which will be post tax. And I'm paying interest on it anyway, which may or may not be tax deductible. It would be the equivalent of me getting a home equity loan and having to pay taxes on the gains of my property when I took out the home equity loan. What am I missing?

anon291 2y ago
There is no loophole. The interest is taxed completely. So the government is probably making more with all the spending. No one is borrowing money to sit in an account. They borrow to spend (immediately taxed as sales and also profit of the seller and interest)
- scoofy 2y ago
  The loophole is the cost basis of the equity resetting — untaxed — at death.
  - toomuchtodo 2y ago
    “Buy, Borrow, Die” https://www.dcfpi.org/all/how-wealthy-households-use-a-buy-borrow-die-strategy-to-avoid-taxes-on-their-growing-fortunes/ https://www.dcfpi.org/all/how-wealthy-households-use-a-buy-b...
gamblor956 2y ago
What am I missing? Stock is a highly liquid asset, the exact opposite of a home. For starters, you don't give up the home (title, possession, or use) when you take out a home equity loan. But when wealthy stockholders borrow against stock, they are realizing the economic value of the stock by using that stock as collateral (i.e., exchanging it in exchange for the loan) but are not being taxed on that realization of income. Also, it's quite uncommon for someone capable of utilizing this scheme to pay any significant amount of interest on the loan (and this was true even before the decade of ZIRP), as quite paradoxically the wealthy pay less interest on larger loans.
hedora 2y ago
You have $1B in stock, and it represents 1% of your brokerage’s assets under management. You periodically borrow $10M from the brokerage using the stock as collateral. They charge 0.25% (i.e., a few percent below inflation) and no minimum payments with the understanding that you will not move your assets.
- refurb 2y ago
  Normal margin rates are 5%+, I could see a big account getting a big discount, but 0.25%? At some point (well above 0.25%) it’s clear that a special rate is being offered that is no longer an arms length loan (IRS Part 1 Section 7872) and the imputed rate will be applied as if the difference is an interest payment from the bank to the customer. But let’s say the client gets 4% instead of the normal 5.5%. If they never pay it back it only takes a few years before they pay more in interest than they would have paid in capital gains taxes. It’s a “loophole” that nobody uses to avoid taxes for a lifetime.
- yywwbbn 2y ago
  > charge 0.25% Do they? I wouldn’t be surprised if their margin was 0.25% but they‘d still be charging it on top of the benchmark rate (~4.8% now) otherwise they’d be losing a lot of money overtime
yywwbbn 2y ago
> I eventually have to come up with the $10 Or you never do that. When you die the cost basis is adjusted and you children don’t have to pay any taxes even if they sell. But, yeah since it’s not actual income taxing it makes no sense. IMHO a wealth tax above a certain (high) threshold would be far more reasonable
lesuorac 2y ago
The appreciation of the stock. Later you die, your stock is now worth $1000 of which your estate pays $0 tax on it (see: stepped up cost basis) and then they pay off the loan and pass the proceeds to your trust. in the interim, you've been able to enjoy the $100 from your stock (which may have a cost basis if $0.0001 since you're a fonder) without paying any taxes. --- Also your interest rate of 10% is a bit high but still basically lower than the appreciation of stock so it kinda doesn't matter. https://tradethatswing.com/average-historical-stock-market-returns-for-sp-500-5-year-up-to-150-year-averages/ https://tradethatswing.com/average-historical-stock-market-r...
- lordloki 2y ago
  So your saying that these loans never get paid back in the lifetime of the borrower? And they just keep taking out more and more loans during their life? X
  - lesuorac 2y ago
    > So your saying that these loans never get paid back in the lifetime of the borrower? Yes. > And they just keep taking out more and more loans during their life? X Well, I'm not making any claims on that but probably. If you took out a $200M loan and only needed to spend say $25M of that it's probably advantageous to re-invest $100M of that back into stocks and then if they appreciate (too much?) you'd want to do another loan again.
- Gunax 2y ago
  So if I am understanding this right, the inheritance gets its cost basis reset. If that's true, then I think we should be attacking the stepped up cost basis instead.
  - lesuorac 2y ago
    I don't believe anybody has suggested attacking anything (in this thread). However, I would say the issue with attacking the stepped up cost basis is that it occurs ~50 years into the future. By taking out a loan the value of the stock has been realized for all intents and purposes except for tax. That should be considered the loophole imo (see article).

by bko 2y ago

anon291 2y ago

There is no loophole. The interest is taxed completely. So the government is probably making more with all the spending. No one is borrowing money to sit in an account. They borrow to spend (immediately taxed as sales and also profit of the seller and interest)

scoofy 2y ago
The loophole is the cost basis of the equity resetting — untaxed — at death.
- toomuchtodo 2y ago
  “Buy, Borrow, Die” https://www.dcfpi.org/all/how-wealthy-households-use-a-buy-borrow-die-strategy-to-avoid-taxes-on-their-growing-fortunes/ https://www.dcfpi.org/all/how-wealthy-households-use-a-buy-b...

gamblor956 2y ago

What am I missing? Stock is a highly liquid asset, the exact opposite of a home. For starters, you don't give up the home (title, possession, or use) when you take out a home equity loan. But when wealthy stockholders borrow against stock, they are realizing the economic value of the stock by using that stock as collateral (i.e., exchanging it in exchange for the loan) but are not being taxed on that realization of income. Also, it's quite uncommon for someone capable of utilizing this scheme to pay any significant amount of interest on the loan (and this was true even before the decade of ZIRP), as quite paradoxically the wealthy pay less interest on larger loans.

hedora 2y ago

You have $1B in stock, and it represents 1% of your brokerage’s assets under management. You periodically borrow $10M from the brokerage using the stock as collateral. They charge 0.25% (i.e., a few percent below inflation) and no minimum payments with the understanding that you will not move your assets.

refurb 2y ago
Normal margin rates are 5%+, I could see a big account getting a big discount, but 0.25%? At some point (well above 0.25%) it’s clear that a special rate is being offered that is no longer an arms length loan (IRS Part 1 Section 7872) and the imputed rate will be applied as if the difference is an interest payment from the bank to the customer. But let’s say the client gets 4% instead of the normal 5.5%. If they never pay it back it only takes a few years before they pay more in interest than they would have paid in capital gains taxes. It’s a “loophole” that nobody uses to avoid taxes for a lifetime.
yywwbbn 2y ago
> charge 0.25% Do they? I wouldn’t be surprised if their margin was 0.25% but they‘d still be charging it on top of the benchmark rate (~4.8% now) otherwise they’d be losing a lot of money overtime

yywwbbn 2y ago

> I eventually have to come up with the $10 Or you never do that. When you die the cost basis is adjusted and you children don’t have to pay any taxes even if they sell. But, yeah since it’s not actual income taxing it makes no sense. IMHO a wealth tax above a certain (high) threshold would be far more reasonable

lesuorac 2y ago

The appreciation of the stock. Later you die, your stock is now worth $1000 of which your estate pays $0 tax on it (see: stepped up cost basis) and then they pay off the loan and pass the proceeds to your trust. in the interim, you've been able to enjoy the $100 from your stock (which may have a cost basis if $0.0001 since you're a fonder) without paying any taxes. --- Also your interest rate of 10% is a bit high but still basically lower than the appreciation of stock so it kinda doesn't matter. https://tradethatswing.com/average-historical-stock-market-returns-for-sp-500-5-year-up-to-150-year-averages/ https://tradethatswing.com/average-historical-stock-market-r...

lordloki 2y ago
So your saying that these loans never get paid back in the lifetime of the borrower? And they just keep taking out more and more loans during their life? X
- lesuorac 2y ago
  > So your saying that these loans never get paid back in the lifetime of the borrower? Yes. > And they just keep taking out more and more loans during their life? X Well, I'm not making any claims on that but probably. If you took out a $200M loan and only needed to spend say $25M of that it's probably advantageous to re-invest $100M of that back into stocks and then if they appreciate (too much?) you'd want to do another loan again.
Gunax 2y ago
So if I am understanding this right, the inheritance gets its cost basis reset. If that's true, then I think we should be attacking the stepped up cost basis instead.
- lesuorac 2y ago
  I don't believe anybody has suggested attacking anything (in this thread). However, I would say the issue with attacking the stepped up cost basis is that it occurs ~50 years into the future. By taking out a loan the value of the stock has been realized for all intents and purposes except for tax. That should be considered the loophole imo (see article).