how borrowing against stocks works

[COcheesehead]

What did you do instead to bridge the gap?

I sold my house and bought another in a 60 day window so I could do a back to back closing. I had my proceeds for all of 30 minutes and then it all went into the new house at the closing for the new house that happened right after.

 

[COcheesehead]

The part that I don’t understand is how claiming the interest on this loan bypasses the capital gains I have to report when I sell the equities

I don’t think it does. Those are two separate things.

 

[RetiredHappy]

here is what I can’t wrap my mind around … I don’t see how the Loan somehow bypasses the capital gains tax. I’m not an idiot and I may be when trying to figure out what you guys are saying! If I borrow against my assts, I understand that part. The part that I don’t understand is how claiming the interest on this loan bypasses the capital gains I have to report when I sell the equities

You cannot claim tax deduction on the interest. You are not selling anything. You will need to repay your loan eventually. When you sell your equities, you have to pay capital gains. Two separate events.

 

[COcheesehead]

You cannot claim tax deduction on the interest. You are not selling anything. You will need to repay your loan eventually. When you sell your equities, you have to pay capital gains. Two separate events.

The capital gains are delayed or avoided until you sell. This type of loan allows you to gain liquidity (cash) without selling anything. You still have to pay interest and pay it back, but then it’s just a math equation of paying cap gains vs paying interest to determine if it is right for you.

 

[marko]

This is the "Buy, Borrow, Die" strategy I think.

Borrow against your holdings, pay the interest but not the principal and upon your death, the estate pays off the loan and the heirs get a step up in basis on the securities left, which by now have grown considerably.

Private lenders and wealth managers for the UHNW are often very accommodating and security lines of credit can go decades with minimal service. Usually there is no principal due or maturity date involved. If they're holding $50M of your money, I'd expect you'd get certain courtesies.

But I could be wrong or thinking of something else.

 

[Retired Expat]

here is what I can’t wrap my mind around … I don’t see how the Loan somehow bypasses the capital gains tax. I’m not an idiot and I may be when trying to figure out what you guys are saying! If I borrow against my assts, I understand that part. The part that I don’t understand is how claiming the interest on this loan bypasses the capital gains I have to report when I sell the equities

Since you aren’t selling anything you don’t recognize any profit or loss on the capital

The incentive for this is obviously the short term bridge loan. But also these security backed loans have none of the fees that mortgages and standard loans have. It is almost like a line of credit. So super easy and relatively cheap. Need a 100k quick to pay off the shopping trip in Paris but don’t want to sell anything ? Short term loan at SOFR + a couple points beats the hell out of or what your credit card will charge you. Particularly if you know that money is coming in to pay it off down the line.

I used to do it to flip houses. Making money using other peoples money!

 

[bada bing]

You cannot claim tax deduction on the interest. You are not selling anything. You will need to repay your loan eventually. When you sell your equities, you have to pay capital gains. Two separate events.

per Schwab:
Margin interest is tax-deductible as an investment interest expense, but only if you itemize your deductions on your federal income tax return and use the borrowed funds to purchase taxable investments.
Key limitations and rules for claiming the deduction include:
Income Cap: You cannot deduct more margin interest than your net investment income for the tax year. Net investment income includes taxable interest, dividends, and short-term capital gains.

 

[SnowballCamper]

Now I know how the likes of Warren Buffet can pay the same income tax as his secretary.... Seriously, thanks.

 

[NW-Bound]

The capital gains are delayed or avoided until you sell. This type of loan allows you to gain liquidity (cash) without selling anything. You still have to pay interest and pay it back, but then it’s just a math equation of paying cap gains vs paying interest to determine if it is right for you.

Yes. I have not needed to do this, but I can see people wanting a quick short loan in order to wait to sell some stocks with the long-term cap gain treatment instead of the short-term cap gain.

 

[HappilyRetired]

Since you aren’t selling anything you don’t recognize any profit or loss on the capital

The incentive for this is obviously the short term bridge loan. But also these security backed loans have none of the fees that mortgages and standard loans have. It is almost like a line of credit. So super easy and relatively cheap. Need a 100k quick to pay off the shopping trip in Paris but don’t want to sell anything ? Short term loan at SOFR + a couple points beats the hell out of or what your credit card will charge you. Particularly if you know that money is coming in to pay it off down the line.

I used to do it to flip houses. Making money using other peoples money!

I get that part. The part I don’t get is how borrowing against your portfolio helps with your capital gains when you sell ?

 

[COcheesehead]

I get that part. The part I don’t get is how borrowing against your portfolio helps with your capital gains when you sell ?

It doesn’t

 

[HappilyRetired]

You cannot claim tax deduction on the interest. You are not selling anything. You will need to repay your loan eventually. When you sell your equities, you have to pay capital gains. Two separate events.

That is what I thought. I could have sworn the topic of capital gains was linked to the equity loan when it was first introduced in this stream.

 

[RetiredHappy]

That is what I thought. I could have sworn the topic of capital gains was linked to the equity loan when it was first introduced in this stream.

Not as far as I am aware. I used it for a home purchase back in 2014.

 

[Sunset]

Now I know how the likes of Warren Buffet can pay the same income tax as his secretary.... Seriously, thanks.

Warren probably doesn't do this.

He just sells some stock and pays the 0,15,20 percent tax rate depending upon how much he sells per year, minus the Billions of dollars he gives away every year.

A lot of his going places and doing things are really for the business, so the business pays for his private jet flying (NetJets is owned by Berkshire Hathaway) and expenses.

He is so cheap (admirable quality) that he would get breakfast at McD's $2 egg McMuffin and coffee. He lives in the same house he bought ages ago.

 

[2cheap2eat]

The rates are usually a couple of percent above Prime rate. When interest rates were close to 0, the leverage rate on the brokerage account was about 2 to 3 percent. You may be looking at old posts.

I have a Fidelity Line of Credit (LOC), current interest is about 6.5%

 

[marko]

I get that part. The part I don’t get is how borrowing against your portfolio helps with your capital gains when you sell ?

You don't sell. Ever. The idea is, you borrow and borrow, pay just the interest until you die. Meanwhile, the portfolio balance grows and grows.

The estate pays off the loans, the heirs get the step up. Works best for older people.

 

[Koolau]

Now I know how the likes of Warren Buffet can pay the same income tax as his secretary.... Seriously, thanks.

I don't borrow on my stocks but, generally, I keep my taxes low because I'm stacking up unrealized gains. If I chose to spend those gains, THEN, I'd be paying more in taxes. Buffet too. He spends virtually nothing compared to his wealth. So no need to realize a lot of his gains. That's what "wage slaves" don't understand about (us) "rich people").

 

[COcheesehead]

There’s a guy complaining on the Fidelity forum that he got a margin call so he sold some stock to pay it off, but the stock was the collateral which then created a second margin call. My point is know what you are getting into and how to use it or you might create more of a mess.

 

[dheb]

here is what I can’t wrap my mind around … I don’t see how the Loan somehow bypasses the capital gains tax. I’m not an idiot and I may be when trying to figure out what you guys are saying! If I borrow against my assts, I understand that part. The part that I don’t understand is how claiming the interest on this loan bypasses the capital gains I have to report when I sell the equities

If you use this strategy until you die, your heirs inherit the asset at a stepped-up basis, so there aren't any capital gains for your heirs to report. Poof! Gone! So it would be a decent tax strategy for someone who is getting up there in age, has high gains in a brokerage account, wants to use some of that money but doesn't want to trigger gains by selling, and wants to leave assets to an heir in a few years. The steppped-up basis on their death might be worth paying the interest for a while.

 

[copyright1997reloaded]

here is what I can’t wrap my mind around … I don’t see how the Loan somehow bypasses the capital gains tax. I’m not an idiot and I may be when trying to figure out what you guys are saying! If I borrow against my assts, I understand that part. The part that I don’t understand is how claiming the interest on this loan bypasses the capital gains I have to report when I sell the equities

Buy, Borrow and DIE. Die is the key term here in terms of avoiding capital gains taxes as the assets get a step up in basis when you croak.

 

[tenant13]

here is what I can’t wrap my mind around … I don’t see how the Loan somehow bypasses the capital gains tax. I’m not an idiot and I may be when trying to figure out what you guys are saying! If I borrow against my assts, I understand that part. The part that I don’t understand is how claiming the interest on this loan bypasses the capital gains I have to report when I sell the equities

If you are able to spread those capital gains over time, you can avoid taxes. I was purchasing a property last year and I needed 80k - fast - to meet the seller's price. I wanted to sell another property but the timing worked against me. So I sold some of my stock without thinking. I chose wrong equities and it was mostly CG. It took me to the next tax bracket and cancelled my ACA subsidies. It was a 25k mistake that would have been easily avoided if I took a loan - the other property sold now and I could have covered the loan without incurring any interest.

I intend to use the cash from the sale to make sure that my income until I hit 65 does not exceed ACA subsidies threshold. I could maybe replenish my ROTH with conversions as well but that would conflict with ACA. I'll lok into it. Chat GPT could help

Additional information: I've learned since that I could take a loan (up to 50k or half the total value whichever is lower) from my solo 401k (it's a self -directed retirement plan that can be opened for single person business - easy). It has to be repaid back to the plan, like any other loan, but that just means that I'm paying the interest to myself - there's no financial institution involved in this; I'm a trustee and the sole beneficiary of my own 401k so I approve the loan. In order to cover the 25k tax bill (which I didn't have cash at hand for) I took the loan and now I just have to deposit a few hundred monthly to the 401k. At this point I do have a cash from the older property sale so it's up to me how I cover the loan - I think I keep it.

 

[pjigar]

Buy, Borrow and DIE. Die is the key term here in terms of avoiding capital gains taxes as the assets get a step up in basis when you croak.

You don't sell. Ever. The idea is, you borrow and borrow, pay just the interest until you die. Meanwhile, the portfolio balance grows and grows.

The estate pays off the loans, the heirs get the step up. Works best for older people.

This "strategy" has a big hole which I can't explain. Please explain if you know the answer. I will use an example to better explain the hole. Let's say you are *really* rich and belong to 20% capital gains tax bracket. Let's say you secure a line of credit at 5% interest rate. The break even period is 4 years in this case: 5%*4 years = 20% total interest vs 20% cap gains tax. So if you borrow till you die (which would be significantly longer than 4 years) then you are paying a lot more money in interest vs what you would have paid in capital gains tax. What I don't understand is why popular media loves to talk so much about buy-borrow-die "strategy"?

The only viable explanations I got why rich can't/won't sell equity: Equity is not liquid, they need voting power associated with the equity, etc.

 

[pjigar]

Additional information: I've learned since that I could take a loan (up to 50k or half the total value whichever is lower) from my solo 401k (it's a self -directed retirement plan that can be opened for single person business - easy). It has to be repaid back to the plan, like any other loan, but that just means that I'm paying the interest to myself - there's no financial institution involved in this; I'm a trustee and the sole beneficiary of my own 401k so I approve the loan. In order to cover the 25k tax bill (which I didn't have cash at hand for) I took the loan and now I just have to deposit a few hundred monthly to the 401k. At this point I do have a cash from the older property sale so it's up to me how I cover the loan - I think I keep it.

One of the big downside of 401(k) loans which is not obvious: You are pressing a pause button on the portfolio growth. i.e. The borrowed money stops growing in your portfolio and compounding clock gets shorter. Another minor issue is that you are paying interest using the after-tax money but you may pay tax again on that interest money when you eventually withdraw it from the 401k plan. Double taxation issue is not a big deal but stopping your portfolio growth can cost you dearly.

 

[marko]

This "strategy" has a big hole which I can't explain. Please explain if you know the answer. I will use an example to better explain the hole. Let's say you are *really* rich and belong to 20% capital gains tax bracket. Let's say you secure a line of credit at 5% interest rate. The break even period is 4 years in this case: 5%*4 years = 20% total interest vs 20% cap gains tax. So if you borrow till you die (which would be significantly longer than 4 years) then you are paying a lot more money in interest vs what you would have paid in capital gains tax. What I don't understand is why popular media loves to talk so much about buy-borrow-die "strategy"?

The only viable explanations I got why rich can't/won't sell equity: Equity is not liquid, they need voting power associated with the equity, etc.

I think that the UHNW can often get a much lower rate. Prime plus a small spread. A lender can be accommodating because they benefit from an overall larger portfolio which will grow even larger.

Then that $X,000,000-plus-20%-taxes (paid upfront) that you didn't remove from the portfolio could be earning 8-10%, outpacing the cost of the interest-only loan. And its compounding to boot. In some cases the interest is deductible.

It all works better when you're 67 but not quite as well if you're 27. You can also borrow more. Remember, the goal is the step up...that's the "die" part.

Why does the media talk about it? I'd guess that it perpetuates the narrative that, as Fitzy observed: "The rich are different from you and me" and everybody loves to have a villain.

 

[COcheesehead]

Bezos says the buy, borrow/die strategy is a myth.

Jeff Bezos says there is ‘no truth’ to the ‘buy borrow die’ tax strategy

The "buy, borrow, die" strategy refers to the practice of wealthy founders or investors borrowing against their assets and using the loan proceeds as income.

www.cnbc.com