How rich people are using cheap loans to cash out without taking a big tax hit (2024)

FAQs

How rich people are using cheap loans to cash out without taking a big tax hit? ›

They do this because selling stock is taxed, but loans aren't. And the interest payments on loans is far lower than the taxes due from a stock sale. This allows their stock portfolio (and thus wealth) to keep growing, and growing much faster than it would if they kept selling stock to fund their lifestyle.

Currently, wealthy households can finance extravagant levels of consumption without even paying capital gains taxes on the accruing wealth by following a “buy, borrow, die” strategy, in which they finance current spending with loans and use their wealth as collateral.

Wealthy people aren't afraid of borrowing. But they typically don't borrow money to live beyond their means or because they failed to save for emergencies or make a plan to cover expenses. Instead, rich people tend to use debt as a tool to help them build more wealth.

How is this possible? The low effective tax rate arises in part because U.S. billionaires with large stock portfolios and other appreciated assets can borrow money using their considerable financial assets as collateral and then pay little to no taxes on the cash they use to finance their lifestyles.

By pledging their appreciating assets as collateral, billionaires are able to live off their loans as long as their loan payments don't exceed their investment gains.

While millionaires are less likely to have a cash back card than the average American, they're more likely to have every other major type of credit card, including travel rewards cards, balance transfer cards, gas and grocery cards, and sign-up bonus cards.

Some examples include: Business Loans: Debt taken to expand a business by purchasing equipment, real estate, hiring more staff, etc. The expanded operations generate additional income that can cover the loan payments. Mortgages: Borrowed money used to purchase real estate that will generate rental income.

Living off interest involves relying on what's known as passive income. This implies that your assets generate enough returns to cover your monthly income needs without the need for additional work or income sources. The ideal scenario is to use the interest and returns while preserving the core principal.

They Use Accounts That Come With Extra Perks

Rich Americans often get extra perks via exclusive credit cards or their use of private banks. “Some exclusive perks include concierge services, premium credit cards and preferential loan terms,” said Erika Kullberg, personal finance expert and founder of Erika.com.

What are some tax loopholes? ›

Common types of securities include bonds, stocks and funds (mutual and exchange-traded). Funds and stocks are the bread-and-butter of investment portfolios. Billionaires use these investments to ensure their money grows steadily.

While giant companies enjoyed record profits in recent years, many still pay lower tax rates than most working families. That's in part because many take advantage of generous tax breaks and stash profits in tax havens around the world.

An illegal money lender might be a friend or acquaintance, or they might simply be someone known around your area for lending money. They will often deal in cash, seldom provide any paperwork, and will demand very high interest rates (or they may not even be clear about what you have to pay back).

Personal loans can be made by a bank, an employer, or through peer-to-peer lending networks, and because they must be repaid, they are not taxable income. If a personal loan is forgiven, however, it becomes taxable as cancellation of debt (COD) income, and a borrower will receive a 1099-C tax form for filing.

Since income is not one of the five factors that determine a credit score, the wealthy are just as likely to have a low credit score as the people with lower income. The rich can miss payments, rely too heavily on credit, and open too many new accounts, all of which may lower their credit score.

They don't need to sell stocks, which would trigger capital gains taxes. Instead, they can take loans against their shares. Securities based lending, securities based lines of credit, home equity lines of credit and structured lending are options for leveraging assets without selling them.

Though personal loans are not tax-deductible, other types of loans are. Interest paid on mortgages, student loans, and business loans often can be deducted on your annual taxes, effectively reducing your taxable income for the year. You shouldn't need a tax break to afford a personal loan.

Tax-aware borrowing is when you take on debt in a way that may allow you to deduct the interest expenses. Because there are rules surrounding what and how much you can deduct, borrowers may consider coming up with a debt strategy that makes the most of these allowances.

Limited liability protection

Buying a house with an LLC means avoiding potential lawsuits as a business owner. For example, you have protection against liability for debts or being sued because of someone injuring themselves on the property.