Borrowing Against Shares
This method of borrowing allows share holders to realize the value of their stock market positions as cash, without incurring capital gains tax. It works very simply; rather than selling their shares, the holder can get a cash loan for their equivalent value, using them as collateral. By buying ‘puts’ and ‘calls’ for the shares they can ensure that they can be bought or sold later at a set price, offering protection against any depreciation that may occur.
The holder then has the cash available to do with what they will. If they don’t repay it, the shares go to the bank, but this would occur some time down the line. In the mean time the money gained has been working for them since the original deal, dramatically lessening the impact of the tax bill when it comes.
Many top earning executives when negotiating their contract will be offered shares, often worth much more than their actual salary, as an incentive to put their signature on the dotted line. Of course, owning shares of such high value, will lead to a high tax bill.
However, this eventuality can be side stepped by the executive in question choosing options instead of shares (options being the right to eventually buy the shares when they see fit.)
As gains from options aren’t taxed until the option is exercised (i.e. the executive actually buys the shares) the holder can see the capital at their disposal go up, without being duty bound to pay tax on the increase.
As well as using stock options to this end, some highly paid individuals have their pay put into a deferred compensation plan, where funds can grow without being taxed for decades before any payment is due.
Taxes payable on income from the sale of shares can be offset by the losses from the sales of shares. By planning ahead a trader can realize the tax benefit of a loss and offset his gains, without actually offloading the shares he has in a losing position.
The IRS forbid traders to sell at a loss and re-buy the same shares within 30 days, however this can be worked around by buying another block of the losing shares, equal to the amount already held, 31 days in advance. Buying ‘puts’ and ‘calls’ will effectively freeze their value, then it’s a case of waiting the 31 days out and selling the original block of shares.
This way the loss occurs, and the trader gets the tax benefit of it, but he still has the same number of those losing shares, at the same value as before.
Borrowing Against Property
To avoid paying tax on the income generated by real estate, its owner can borrow against it in such a manner that they effectively sell the property, without paying capital-gains.
By entering into a partnership with a potential buyer, the owner of the property can contribute their real estate to the partnership, alongside the assets of the other partner. The partnership can then borrow a sum equal to the value of the property using it as collateral, which is then distributed to the seller.
Although the value of the property is now in the owner’s hands in cash form, technically there’s been no sale, so none of the taxes that would have otherwise been charged are applicable.
Joan Bret writes on various tax issues, from filing timely returns, to finding the best ISA rates.
- Tax debt reduction: Offers in Compromise explained (2011tax.org)