When to take debt to defer taxable gains for no/lower tax?

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harikaried
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When to take debt to defer taxable gains for no/lower tax?

Post by harikaried »

It's often recommended to avoid realizing taxable gains in the hopes of selling/donating/passing those securities at 0%, so one natural alternative is to borrow the money instead, but what rates are reasonable?

For those who tax loss harvested / invested at the bottom in 2020, today the gains are probably nearing 100%, so $10k originally invested would have $1.5k long-term capital gains tax netting $18.5k. If instead one borrowed that amount, it would take about 3 months to accrue that much interest at 32%. And if one was making roughly the same amount of monthly payments to the loan so the average duration was still 3 months, that means someone could borrow $18.5k at 32% paying back $3.4k/mo over 6 months and still be less than what would have been owed in capital gains tax.

Just very broadly splitting up loan types to approximate rates (and assuming 0% origination fees) then calculating months to break even in terms of interest vs tax on 100% gains:
  • 32% cash advance - 6 months
  • 16% credit card - 12 months
  • 8% personal/student loan - 24 months
  • 4% auto loan / HELOC - 49 months (4 years, 1 month)
  • 2% mortgage - 97 months (8 years, 1 months)
  • 1% margin loan - 195 months (16 years, 3 months)
Of course, if one's gains aren't quite at 100% and instead say 33% from some years of "regular" growth, instead of the $10k basis growing to $20k for 50% basis, the $10k growing to $13,333 is then 75% basis, and the above list of months is cut in half. So the 16% credit card is now 6 months to break even. And similarly from a couple years growth of 14% total gains resulting in 87.5% basis makes the 8% personal loan 6 months to break even.

Many people here probably have access to more reasonable rates around say 4% or better, so it seems like if one has even modest 14% long term capital gains, it's cheaper to borrow money than paying taxes if one can pay it back within a year?

Edit: More generally, this calculation works even when future tax rate isn't 0%, e.g., dropping from 20% to 15% capital gains tax rates (roughly divide the above months for 15% by 3), not needing to pay 3.8% net investment income tax, moving states for more favorable rates. Even if the tax rate is the same, there is benefit in deferring to keep what-would-have-been-taxed invested.
Last edited by harikaried on Sun Sep 19, 2021 10:06 am, edited 2 times in total.
bradpevans
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by bradpevans »

I'm confused.
Gains are good as i see it.

if you donate / pass down, no need to sell.

If you want for 100% gains to go back to zero, sure you avoid 15% LTCG. You also avoid 85% profit.

If you do the loan, what then do you do with the stock?
shess
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by shess »

Search the web for “buy borrow die”. If your assets appreciate faster than your debts, it can work out. Works best if your assets are much larger than your cash needs. If not, one bad year can cause everything to unwind catastrophically.
humblecoder
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by humblecoder »

harikaried wrote: Fri Sep 17, 2021 1:35 pm Many people here probably have access to more reasonable rates around say 4% or better, so it seems like if one has even modest 14% long term capital gains, it's cheaper to borrow money than paying taxes if one can pay it back within a year?
Well that's the trick, isn't it? What if you can't pay it back? If I had a cash need that to sell stock to satisfy, that usually means that I can't "cash flow" that need.
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harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

bradpevans wrote: Fri Sep 17, 2021 2:09 pmIf you want for 100% gains to go back to zero, sure you avoid 15% LTCG. You also avoid 85% profit.
Yes gains are good and we don't want them to go back down to 0%. I'm trying to figure out how much interest over some time is worthwhile to pay to not pay capital gains tax as we did TLH last year with VTI/SCHB close to 100% gains. Maybe another way to look at it is in order to access $XX cash, can I pay a bank $YY interest that is less than $ZZ taxes to government?
bradpevans wrote: Fri Sep 17, 2021 2:09 pmif you donate / pass down, no need to sell.
Yup, and another way for 0% LTCG rate is years of low income in 10% or 12% tax bracket (under $80k income married).
Topic Author
harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

shess wrote: Fri Sep 17, 2021 2:19 pmSearch the web for “buy borrow die”. If your assets appreciate faster than your debts, it can work out.
Ah thanks! Found this discussion from earlier this year: Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth

That does seem quite similar with the key aspect I'm looking at here is the repayment of the loan. The other thread seems to focus on low margin rates that continuously accrue interest until stepped up basis with the hopes of market returns outpacing interest rate.

If one has cash flow from regular income, interest/dividends, RMDs, social security, etc., those can be used to pay off a loan / line that was drawn upon to avoid a taxable event from realizing significant gains. I suppose those "Rich Americans" likely do have some cash flow, but it wasn't clear or explicit that the debt was being repaid.
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harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

humblecoder wrote: Fri Sep 17, 2021 2:30 pm
harikaried wrote: Fri Sep 17, 2021 1:35 pm Many people here probably have access to more reasonable rates around say 4% or better, so it seems like if one has even modest 14% long term capital gains, it's cheaper to borrow money than paying taxes if one can pay it back within a year?
Well that's the trick, isn't it? What if you can't pay it back? If I had a cash need that to sell stock to satisfy, that usually means that I can't "cash flow" that need.
That specific example was for "modest" 14% total gains, but the original example of 100% gains, one would have 97 months at 2% to pay the same as what would have been owed in taxes. If the immediate cash need was to sell the tax lot with $10k basis and 100% gains, $18.5k repaid 8.1 years is $200/mo. And if one has even more cash flow, it's even cheaper to go the loan route in paying back the loan (and less total interest).

But yes indeed on the flip side, if cash flow would not be sufficient, it does make sense to realize gains and pay the tax instead. And one can evaluate this for each of the tax lots for potentially multiple position, so sell those with lower (or even negative) gains as the capital gains will be small (relative to the interest on the more-basis balance), avoid selling higher gains, and borrow a smaller amount as now one has cash from the sale.
Last edited by harikaried on Fri Sep 17, 2021 10:57 pm, edited 1 time in total.
shess
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by shess »

harikaried wrote: Fri Sep 17, 2021 5:07 pm
shess wrote: Fri Sep 17, 2021 2:19 pmSearch the web for “buy borrow die”. If your assets appreciate faster than your debts, it can work out.
Ah thanks! Found this discussion from earlier this year: Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth

That does seem quite similar with the key aspect I'm looking at here is the repayment of the loan. The other thread seems to focus on low margin rates that continuously accrue interest until stepped up basis with the hopes of market returns outpacing interest rate.

If one has cash flow from regular income, interest/dividends, RMDs, social security, etc., those can be used to pay off a loan / line that was drawn upon to avoid a taxable event from realizing significant gains. I suppose those "Rich Americans" likely do have some cash flow, but it wasn't clear or explicit that the debt was being repaid.
On re-reading your post, I think I misunderstood things, anyhow :-).

One thing I'm trying to figure out how to phrase is that your tax cost isn't just a percentage you have to pay to turn the assets into cash, you also remove that liability. Whereas if you take a loan, at the end you still have an asset with an imputed tax liability. So if you believe you can somehow shift that asset without taxes (0% gains rates, give to charity, basis step-up at death), it makes more sense to take the loan to keep the gains in place. But if you're going to sell the asset in five years, say, then you'll get less advantage from avoiding the taxes now, you're simply shifting the timing of the payment around. I guess you'd have to do a long-term analysis on things to get a real angle on that.

Also, capital gains rates may or may not remain 15% on these assets.

Personally, I've certainly done this kind of thing. For instance, the last time we used financing to purchase a vehicle, I just wrote a check against our margin account and then paid down the balance over eight months or so. Though these days in that situation I'd probably go with dealer financing (and still pay it down ASAP).
TropikThunder
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by TropikThunder »

harikaried wrote: Fri Sep 17, 2021 5:00 pm I'm trying to figure out how much interest over some time is worthwhile to pay to not pay capital gains tax as we did TLH last year with VTI/SCHB close to 100% gains. Maybe another way to look at it is in order to access $XX cash, can I pay a bank $YY interest that is less than $ZZ taxes to government?
Are the shares with ~100% gain the only available ones to sell?

People twist themselves into pretzels to avoid taxes, even if they end up with less money afterwards.
Topic Author
harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

shess wrote: Fri Sep 17, 2021 5:37 pmBut if you're going to sell the asset in five years, say, then you'll get less advantage from avoiding the taxes now, you're simply shifting the timing of the payment around.
Yes indeed. The premise here is one would be able to avoid paying gains tax, so if one does pay the same 15% tax anyway in 5 years, that likely would have been excess interest paid if doing a loan instead. However, if one is accumulating and growing the taxable account, most likely these current "best" shares to potentially sell become those with even larger gains as the newer investments would have lower gains and be more preferable to sell if one has cash needs in say 5 years, so this results in these current day shares more likely to persist to 0% tax.
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harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

TropikThunder wrote: Fri Sep 17, 2021 6:02 pmAre the shares with ~100% gain the only available ones to sell?
For long-term capital gains, yes these are the only shares, and they're close to 50% basis. The next upcoming switch from short to long are currently close to ~33% gains matching up with my second example of 75% basis. But in general, yes it's important to look at all shares / tax lots as there could be some with losses to sell.
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harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

shess wrote: Fri Sep 17, 2021 5:37 pmcapital gains rates may or may not remain 15% on these assets
I was thinking about this a bit more, and it seems like if the rates go down to favor selling instead of loan, one could sell and pay down/off the loan. The simple example would be a low year of income allowing for 0% long-term capital gains tax, so pay no taxes and less interest going forwards.

This would also apply if one shifts out of net investment income tax range or moves to a state that taxes gains more favorably. And similarly, if one is currently subject to both of those and 20% capital gains rate for say a combined 37.1%, that really does favor taking a loan where even 32% cash advance takes over a year to match the tax on 100% gains, and with a 1% margin loan, that's over 45 years. I guess that's why those with really high taxable accounts and taxes would really want to do something like this.
hachiko
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by hachiko »

What is the point? This sounds like a homework assignment or something. You can borrow on margin for 4-5%. Why would anyone care about comparisons of the tax rate to a 33% interest rate?

Also, what person is in the top tax bracket and would ever be forced to decide between selling the stock or taking a loan at 33%?
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Thesaints
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by Thesaints »

After paying back the loan, one still has unrealized gains that will eventually be taxed.
It only works if one never sells those shares.
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harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

shess wrote: Fri Sep 17, 2021 5:37 pmlast time we used financing to purchase a vehicle, I just wrote a check against our margin account and then paid down the balance over eight months or so. Though these days in that situation I'd probably go with dealer financing
Hmm… We did buy a new vehicle earlier this year, but we sold stocks and probably would have been better drawing on our HELOC and paying it back.

We sold 250 shares of SCHB in February acquired September realizing about 19% / $4k short term gains, which will use up some of our carryover losses from 2020 TLH. Theoretically those carryover losses could have offset future income at say 24% marginal rate saving about $1k tax. If instead we borrowed $22k at 3.75% and paid it back over 12 months, we would have paid $500 in interest -- half of the future tax savings. And most likely we would have paid it off in about 4 months anyway dropping the total interest paid under $200.

There was some benefit in not doing new financing, e.g., no extra paperwork and wife didn't need to leave work to sign any documents. So if we did have a margin account, we could have done it similar to your experience. Even with Fidelity's current 7.8% margin rate, paying it back in 4 months would have been less than $400 interest still saving more than half of the tax.

If we held onto those shares, today they would have been long-term with 16% additional gains over when we sold so about 38% total gains. Not quite sure how that should be accounted for, but it could have very well gone down back to 0% total gains.

But then again, at least for this vehicle purchase, we're talking about less than $1k income tax vs hundreds of dollars in interest. Maybe not worth the extra math for some people?
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harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

hachiko wrote: Fri Sep 17, 2021 11:55 pmWhy would anyone care about comparisons of the tax rate to a 33% interest rate?
One could avoid paying tens of thousands of capital gains taxes by paying interest instead if one cares about saving money.
hachiko wrote: Fri Sep 17, 2021 11:55 pmwhat person is in the top tax bracket and would ever be forced to decide between selling the stock or taking a loan at 33%?
The example I gave was with 15% long-term capital gains, so that's pretty regular income tax bracket, and I gave examples of powers of 2s ranging from 1% to 32% to hopefully give a better sense of how things change based on the type of financing available. But yes, hopefully most people have options other than 30%+ rates, but even then, it could still be cheaper to do that instead of realizing gains.
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harikaried
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by harikaried »

Thesaints wrote: Sat Sep 18, 2021 12:34 amIt only works if one never sells those shares.
Current tax law has 0% long-term capital gains tax rate that allows for Tax gain harvesting or just plain selling positions with gains without incurring taxes.
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PicassoSparks
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Re: Avoid capital gains tax with "short term" 32% interest rate cash advance loans?

Post by PicassoSparks »

Your dramatic title meant it took me awhile to understand what you are saying which is:

We know that, in general, the longer we can delay paying taxes, the more money we have to grow. It may even make sense to take out loans that we can repay quickly to defer paying taxes. Especially if we think we can defer taxes to death when the step up rule (if it should persist) causing our heirs to start from a new tax basis.

How quickly does your scenario collapse if I foresee ever having to cash out my investments in retirement?
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harikaried
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Re: When to take debt to defer taxable gains for no/lower tax?

Post by harikaried »

PicassoSparks wrote: Sun Sep 19, 2021 6:06 amHow quickly does your scenario collapse if I foresee ever having to cash out my investments in retirement?
Thanks. I updated the topic title to be more inclusive of other similar situations instead of only for planning for 0% tax rate. If you would pay 20% capital gains tax now vs 15% in retirement, instead of paying the net 5% gains tax, the benefit of preferring debt in the 100% example from earlier would be cut the months to ⅓:
  • 2 months 32% cash advance
  • 4 months 16% credit card
  • 8 months 8% personal loan
  • 16 months 4% HELOC
  • 2 years 8 months 2% mortgage
  • 5 years 5 months 1% margin loan
I think what surprised me to even start this topic is how long the prefer-debt timelines are for the 2% mortgage even though the gains were from last year's purchases.


If you were asking about situations where you're currently 15% capital gains tax and future tax will also be 15%, there is still a benefit in deferring, but that calculation is not as straightforward as it depends on some projected future growth rate. Notably, if you sell now, you need to pay tax potentially from the cash after the sale, but if not selling, the tax is invested in your current position and can keep growing.

Continuing the $10k with 100% growth example, paying $1.5k gains now and reinvesting to grow an additional 120% (say 10 years of 8% growth compounded), the future value would be $40.7k with $3.3k tax netting $37.4k. While not selling now allows the $20k to grow to $44k with $5.1k tax to net $38.9k, so extra $1.5k earnings (basically the same savings as the original 100% gains example looking to get 0% tax instead of 15%). So reusing the original list of break-even months to avoid $1.5k gains tax, if one can pay off 2% borrowing $18.5k before 8 years and 1 month, the interest would be less than the $1.5k "lost" future gains if selling now.
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harikaried
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Re: When to take debt to defer taxable gains for no/lower tax?

Post by harikaried »

harikaried wrote: Sun Sep 19, 2021 10:51 amsituations where you're currently 15% capital gains tax and future tax will also be 15%, there is still a benefit in deferring, but that calculation is not as straightforward as it depends on some projected future growth rate
Should this future growth analysis also apply to those who are deciding to sell at 20% capital gains vs future 15% gains? Does one "just" add the tax savings value to the additional after-tax growth of what-would-have-been-paid-for-tax dollars and compare that to the loan interest?
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