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.
The 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.
or 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..
Right 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.
And 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.
My 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.
Why 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?
You'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.
Hm, 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.
> I don't understand why the average person ever pays short-term capital gains tax.
Because the risk of holding the stock is more than the difference in short vs long term capital gains.
If the stock is worth $1000 in gains, I know I can sell it and lock in the gains today and pay my normal income rate. If I have to hold it for another 6 months, there is a huge risk that it drops more than the 5-10% difference in the tax rate for the average person.
I pay STCG on option contracts written and on (profitable) short sales (where the holding period is defined to be short-term).
Other positions have a defined thesis and, if that thesis gets invalidated, I close out the position sometimes at a gain. I do try to make most of my gains be LTCG, but trying too hard to optimize capital gains rates can lead to poorer investment decision-making/asset allocation.
You can simulate what you want by simultaneously buying an at-the-money protective put and selling an at-the-money covered call. Then regardless of future stock price movement, at expiration (i.e. when the "loan" needs to be repaid) you always transfer the stock away.
Now why don't you plug in this scenario into any Black–Scholes calculator and see how much of a net credit at entry you get (if you even have one). That would be the maximum loan amount you'd be able to get under this scheme. If you could get one at all, the loan amount is tiny compared to the value of the asset.
That's another conversation to have, but the simple answer is do you want the value of your checking account impacted by someone else's purchase of Gamestop, or Enron?
Taking the short position on a stock you own is called selling short against the box. I don't know much about it, just had heard of it, but it sounds like it's been regulated in the US (to reduce its use for tax avoidance) since 1997.
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.
Certainly not capital gains of the order of "all the spending money I need, without any worry about repaying it on time even if the asset goes back down in price."
Your 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.
That'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.
This 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.
You'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.
> 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.
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.
Depends 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.
Can 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).
That's not accurate. It has several benefits (like interest payments being deductible expenses) and wealthy people can continuously borrow to pay off other debts as their other assets appreciate. You just need the rate of appreciation of your assets to be higher than the interest rate. For very big loans, it's quite possible.
Finally, it's also possible to roll the gains into a trust and the cost basis is adjusted to zero on death. [0] So yes, it's tax avoidance.
The above basically arbitrages long-term vs short-term capgains for the price of 1 APY cycle, right? That's ~23% for short in the USA, and up to income-level (37%?) for short-term. Quite a big difference for a 2-5% APY loan that you close after 1 year, and the numbers would seem to scale better the higher you go.
The theoretical assumes SPY increased over the time period. If it decreased, you could of course sell it and pay 0% since your investment lost money, short/long-term gains wouldn’t matter because there wouldn’t be any gains.
Also, people buying rental property from cash they earned from wages or selling their business pay tax on the wages/gains and the rental income, not just the latter...
You 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.
Sure, but you have to stomach the 6% commission you’re paying to the brokers, which really limits this situation to transitory market conditions instead of a get rich quick strategy.
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.