So I’ve seen this post on Instagram here and there. A person has a large amount of assets, stock, real estate, life insurance policy, etc. But no actual income (9-5 maybe I’m not sure how the whole situation plays out).
The posts typically say to take 0 to low interest against the assets and live off that money or use the money to invest? But how do you pay back the loan? Or at least how do people who take advantage of not having to pay taxes take advantage of this scenario?
Appreciate the insights to follow
In: 7
It’s a matter of simple math. If you are wealthy and want to live the next year with a million dollars in living expenses (travel, food, renting a villa for the summer, etc.), you dont want to liquidate your stock portfolio which was making you 10% returns in the past year. On top of that you would have to pay capital gains tax. So instead, you use your credit worthiness to borrow the $1M at 5% interest for example. Now you’ve kept your portfolio working for you at a higher return than cost of the money you borrowed.
>The posts typically say to take 0 to low interest against the assets and live off that money or use the money to invest?
Yep.
>But how do you pay back the loan? Or at least how do people who take advantage of not having to pay taxes take advantage of this scenario?
You don’t, the idea is that taking an action that allows you to repay the loans means a taxable event, so you just keep borrowing. It works as long as the asset base much larger than your living expenses, and increasing in value.
If one has $1 billion in stock and they borrow $10 million over a year, they have $990 million left to borrow against with no growth, but if their $1 billion in stock rises to $1.05 billion, they now have $1.04 billion they can borrow against next year. As long as the price keeps rising they can do that forever (temporary declines are only an issue if they put them in potential margin call territory).
Selling stock would require giving up all the potential future gains of the sold stock, plus paying taxes on the gain (which usually is almost all the value of the stock for people whose asset base is that large).
If the loans are low interest, you would likely make more money from holding onto that money/asset for that time.
Even on a small scale – I can get a 0% interest loan for a year on a buy-now, pay-later deal. So I get the money/product. I can make full use of it, including using it to earn money. And I don’t have to pay anything for it for a whole year.
If, in that time, I put the money I would have spent on it into stocks, shares, investments, saving accounts, whatever, and I get 0.1% interest (I wouldn’t, I’d get far more), then I can actually pay back that loan next year, pay zero interest and pocket the “free money” that investing etc. it made me.
I literally do this myself, on a tiny scale, with BNPL, credit card deals, promotions, etc. I just made free money from Coinbase. I put some in. I got free promotions for doing so. I cashed out. Free money for a little effort and careful reading of the T’s and C’s.
So if I had millions – damn sure I could take out a loan for millions, use those millions to earn money enough, to pay back the millions, plus a small interest rate on the loan, and pocket the extra.
By no means “guaranteed” and not zero-effort, you have to know what you’re doing and the risk you’re taking if things go wrong, but if you have enough money, it’s just another way to make money. If you’re already a millionaire, and the worst that happens (really rarely) is you lose a million, but the best that happens is you might make a quarter of a million by doing almost nothing for a few years? Win-win.
If, in the meantime, you’re not paying taxes on those items because it’s not really your money but a loan, or they belong to your company and not to you personally, even more profit.
Rather than that loan sitting in the loan company’s bank account, earning them 2% interest by doing nothing, it can sit in your investments earning 4% interest plus pay the loan company back its rate (e.g. 2%).
If I loaned you a million dollars today, at a low enough rate, you could buy up houses outright (no mortgage), rent them out, then when it comes to paying back the loan you’re ALMOST guaranteed to be able to sell them on for the same price or more, plus you’ve got a year of rent in the bank, plus whatever else you might do with that money in the meantime (e.g. put the rent that you’ve been paid into an account or investment at even 0.5%). If it goes right you could easily come out 5-10% on top by doing not-very-much with money that wasn’t technically yours. Not to mention, if you yourself lived in one of those houses, you would have no rent or mortgage to pay for a year… even more profit.
If you have money, it’s really easy to make more money. If you don’t, it’s really hard.
If you are very wealthy, banks will bend over backwards to get your business. My ultrawealthy clients typically get secured loans for around 0.5 percent interest. That means you can borrow $250,000 to live on for the year at an interest expense of $1,250.
There are any number of ways to satisfy that $1,250 liability. As others have mentioned, you can simply borrow more money, but the typical solution is to earn ordinary income or realize capital gains and use the proceeds to pay it off. If your gross income for the year is small enough, you won’t have an income tax liability. Otherwise, you will typically use cash flow management techniques to offset income.
At the end of the day, your assets are growing more rapidly than your liabilities, and you are generating substantial cash flow with minimal (or zero) income tax expense.
I’m worth $1B dollars, but it’s all stock in the company I founded. I go to a bank and borrow $10m to fund my lifestyle, and because I’m worth $1b they give me like a 1% interest rate. The next year I do the same. And so on…
Since I’m not selling my shares, I am not paying capital gains on my shares’ value. While borrowing at 1%, my shares are going up in value. At some point, I do end up selling shares and paying taxes, but with the share price increase over the years, the interest and tax are still less than my net gains in wealth. Maybe 5 years down the road, my shares are now worth $2B. I’ve paid like $2m in interest, $10m in taxes on the $50m I sell to pay back the 5 $10 loans. But I’m still let with over $1.9B now.
Latest Answers