I’ve read this description a few times: a rich person (say, Richie Rich) has just about all of their wealth in company shares. The shares are worth, say 40 billion $, and no taxes are owed on the shares until they are sold at a profit.
So, the explanation goes, Richie can contact a financial institution and ask for a 4 million $ loan to support his lifestyle for 2023. His shares serve as collateral to get him a favorable interest rate, and the interest paid on the loan is tax-deductible. He doesn’t have to sell his shares, so he doesn’t get taxed on them.
The part I don’t get is that, even with all this, he still needs to pay back the 4 million, plus the non-deductible part of the interest on it. And in 2024 he will borrow another 4 million to continue the cycle. So does he need to sell some shares after all? And the loan is just there to reduce his tax on the corresponding capital gains?
Mr. Rich can get a loan of $8 million in 2024 to pay back the $4 million loan from 2023 and support his 2024 lifestyle. In 2025 he can get a loan of $12 million, and so on and so on. As long as his stocks are worth much more than his borrowing needs, and he pledges stock as collateral, he will have no problem with this strategy.
As an aside, the loan interest payments won’t necessarily be tax-deductible, especially if he doesn’t have any income to deduct from.
You’re clearly right about the second sentence per the IRS.
But I can’t find anything clear on my question. All of the references talk about “inherited property” and what happens if the heir sells it, but I can’t easily determine what happens if the property is sold by the executor.
Having dealt with my grandparent’s estates, I know that if it is sold to be disbursed, it only pays taxes from the adjusted basis. I can’t tell whether that can be used to pay off debts or if the money that goes towards debts ends up being taxed. I’d assume the former, as if nothing else, the latter becomes very complicated, but I don’t know for sure.
You’re missing a couple of steps in the Buy, Borrow, Die strategy. The goal of leaving his shares untouched is that they will continue to grow unmolested. He’s borrowing $1B/year against $40B when he starts, but when he dies in, say, 20 years, his shares have doubled 3 times using the rule of 72 and average returns. And he’s “only” borrowed say $20B over that time. His estate can cover that fine, and the heirs are still ahead.
People like to talk about market crashes and such, but no one doing this is borrowing even close to what a market crash (typically a 20-30% drop) would make worrisome, and over a long time frame those dips come out in the wash.
It’s called “securities based lending” or “asset based lending”. As it happens, it’s an area where I’ve gained a bit of operational expertise over the past couple years at the consulting firm where I work.
The main purpose of an SBL loan is to provide rich people quick access to cash. Typically for buying a home, investing in a business, or pretty much anything (other than buying more securities. That’s a margin loan). The loans often have no maturity date, so the borrower can basically borrow in perpetuity so long as they make the interest payments.
You don’t have to be “ultra rich” either. SBL loans are perfectly valid for “regular rich” folks with just a couple of million in stocks.
I don’t know that taking out an SBL loan to live off of for extended periods of time is a great strategy. I think there might be other products better suited for that.
In theory perhaps. But the reality is that Richie Rich wouldn’t “owe” anything. The bank would issue a margin call telling him to add more collateral or they would sell off his shares to cover the loan. And in practice, the collateral rates (the % you can borrow against the value of the stocks and whatnot you are using as collateral) are typically such that banks are covered.
Really the banks don’t actually want to be in a position where they need to tell their largest customers they are going to sell off their assets to pay off a loan.
But his will can leave most of his wealth to a Foundation he sets up for his favorite charitable cause, with only a few hundred million to his heirs. And that big donation to the Foundation provides a huge tax deduction.
Yes, but one only needs a collapse in the value of the underlying security to make these loans become nightmares. Enron’s Ken Lay, Bernard Ebbers of Worldcom, and John Rigas of Adelphia all learned this lesson:
And before one responds “well, these guys were frauds”, the pattern does repeat itself with companies that are financially sound but are going through a rough patch. John Rockefeller was once worried enough about a dip in Standard Oil prices impacting loans he had guaranteed he felt it necessary to reassure his wife that they were going to be OK even if the stock kept collapsing.
It didn’t, but the practice of taking loans against the value of personally held shares long outlived him.
I think the more obvious counter-argument would be that not many people rely so heavily on one security. Founders and CEOs are often stuck with a lot of their signature security, making it more imperative to find a different basket for some eggs. That’s serious hubris, thinking your stock will stay on top for a lifetime.