Tax Planning 101: Buy, Borrow, Die | Hacker News Reader

Tax Planning 101: Buy, Borrow, Die

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93 pointsyonibot91 comments

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.

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.

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.

It’s not advice, it’s just explaining the strategy.

Ignoring the costs (of borrowing) and the risks (of winding up deep in debt) makes the article glib and dangerous.

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.

Reading your comments on this thread, you seem to be interpreting the article as advice, rather than an explanation of how the rich avoid tax.

Further down, you'll see:

> My question is: how can I profit from these tax loopholes? How do I apply this if I only make, say, $35000 annually?

Advice or explanation - not really that much difference in this context.

The fed has setup a world where asset prices have only been increasing. Especially assets owned by the wealthy.

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.

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.

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_...

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

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

You pay back last year debt with the money you borrow this year.

VISAs business model in a nutshell, evidently.

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.

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

Yes, you can take out a mortgage for instance

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.

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.

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

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.

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

Now imagine you're a billionaire!

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.

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.

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

If you're paying 8% interest on the debt (Etrade charges a bit less than 8%) that can get out of hand quickly.

That’s less than half the capital gains tax rate. You’d still come out ahead.

Not necessarily…capital gains tax is only paid once while interest must be paid continuously.

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.

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.

Interest rates are almost zero right now (AFR is 0.12% for short term in July), so money is "free" if you're a low enough credit risk, and fully collateralized loans are easy to get at near-AFR rates if you're rich.

I'm not so sure people are doing this to avoid taxes, though, as opposed to truly wanting to remain in the market as much as possible. If I was Bezos and I had faith in Amazon, I wouldn't want to exit any of my position, especially since that can send a negative signal to the market, etc. If I could hold my position and still spend money without racking up nearly any meaningful interest, I'd happily do so, you'd kinda have to be crazy not to since there's no downside (the principal keeps on earning for you and there's very little cost to service the debt). Companies do stuff like this all the time, there are a million good reasons to maintain debt even when you have assets you could otherwise liquidate, especially when rates are low.

Besides, unless it's given away to charity the bulk of the wealth will be taxed at death anyways via estate tax, so I'm not entirely following the nefarious implications here. I guess people are mad that the borrowed and spent money effectively escapes taxes since it's paid by the estate pre-estate-tax, I guess? I'm reasonably sure that no bank would loan someone in this situation anywhere near their entire net worth, so I can't help but feel like this is a very edge-casey small issue that is only a problem in the rare years where interest rates are so low that it makes sense to do this...

So what kind of rich do you have to be to get near AFR loans. Cheapest I've seen is IBKR right now at %1.6 with a margin loan.

Eh, I guess that's not super accurate, no bank will loan at AFR, you're correct.

But an LLC with cash in the bank that you control or owes you a favor can and will, and that's completely on the level as long as you pay AFR rates.

Scroll further down on the IBKR table. 1.6% is the rate everyone gets. If you manage 200 million for example, you pay 0.75%. Some other currencies have 0.5% interest.

https://www.interactivebrokers.com/en/index.php?f=46376

You only need to start loaning out more than $1m to start hitting way below mortgage rate %0.75!!!

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?

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.

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]

> 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).

Great explanation. Thank you. Framing it as retaining the maximum initial gains as a basis for investment makes it much clearer.

I think the point is that people who make 35,000/year are unlikely to have a huge net worth to be able to take advantage of these tax strategies. So, the advice would be to invest as early and often as possible to hopefully be able to take advantage of this strategy later in life... or just be born into intergenerational wealth, where this is going to be most relevant.

Mathematically, the logic works for anyone obtaining their income from capital gains. So it’s not so much about how much you make annually, but about how much of that is capital gains on assets you own.

Realistically, it doesn’t make sense for smaller figures. Banks are unlikely to lend (at the required rates) for small figures, transaction cost and management fees will reduce the gains too much, fixed costs to setup the scheme will be too high, etc.

> 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?

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).

> 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.

You buy an equivalent ETF. So sell your VTI and buy SCHB. It's a different stock ticker!

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/substantiallyidenticals...

A large amount of tax loss harvesting automation services work on the principle I just described, I even used one for a while. You have to tell them which funds you already own elsewhere so they wont trigger that wash sale rule inadvertently, or move all your stock funds to them.

For something like VTI, you have about 4 other companies that have a similar product you can execute it with. Schwab, Fidelity, iShares, SPDR. Other major banks probably also have them, but they're usually not as popular.

Wash sale rules dont apply when selling investments at a profit.

Like ac29 pointed out, wash sales only apply to losses. The motivation for the wash sale rule in the first place is IRS doesn't want you to be able to use a paper loss for tax deduction and let you maintain the same stock position.

Tax gain harvesting is similar, but the opposite of tax loss harvesting in some sense, because instead of a loss, you are taking a gain in a low income year. IRS doesn't care if you are generating capital gains, because for most people with stocks (read: not making low income) it increases your taxes owed.

To my knowledge, there's no wash sale rule on gains. Only losses.

One can sell a stock, pay the gains, and buy it back immediately at current market value making the holdings cost basis today's market value.

Why would you do such a thing? Exactly as the GP said, to take advantage of better capital gains rates during a low income year.

Another fun one is deliberately realizing small gains in a kid's UTMA account then paying a modest sum to file taxes for the kid. Only works for a specific amount of gains/income each year so read up first.

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.

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.

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.

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.

I was more implying when the estate sells something, you charge the original basis of cap gains tax when they try to pay off its debts by liquidating, but illiquid forced asset sale issue is also a good point.

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

Most of the richest did, but is this true of those in the 10 million to 1 billion range?

%80 of the american wealthy are first generation.

No source, and a very unlikely assertion.

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...

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!!

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.

hopefully someone else can find this- but it was only recently that business people started dethroning the inherited wealthy off of the top Forbes spots. Recently as in 1980 or so. So second and third generation children of tycoons were still dominating.

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).

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.

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.

> 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.

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.

The article fails to take these items into account. Omitting major costs is disingenuous at best.

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).

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

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