Why can billionaires avoid taxes on stocks but use them as collateral for loans?

Trevor Noah, host of “Daily Show” recently criticized tax laws that allow billionaires Tesla Inc. TSLA CEO Elon Musk borrow money tax-free using its Tesla shares as collateral to fund its proposed $44 billion takeover of Twitter Inc. TWTR.

Noah argued that there is a contradiction to the idea that unrealized gains on stocks are not eligible for tax but can be used as collateral, apparently giving billionaires such as Musk access to the gains. in shares not realized tax-free.

“You can buy a thing based on what you have? Yes. But when we want to tax you, you can say ‘I don’t have it. “…Just think about the illogicality. It’s such a fun game for billionaires to play because all their money is in [the stock market]”, Noah said.

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Equity collateral loans: The US tax code only taxes investors on capital gains, gains on stocks and other investments, and when they sell the stocks. The IRS considers asset sales to be “taxable events.” Unrealized gains, gains in value of a stock or other asset before it is sold, are not taxable because the owner does not have access to that value until the asset is sold. .

Loans secured by shares allow investors to use their shares as collateral without selling those shares. These loans are a way for billionaires to enjoy the value of their stocks and other assets without selling them and triggering a taxable event. This principle is the same idea that many Americans take advantage of when taking out home equity lines of credit. A home sale is considered a taxable event, but Americans can borrow against the value of their home if its value increases, even if they don’t sell the home or pay taxes on the unrealized gains.

One of the reasons why assets are not taxed on the basis of unrealized gains is that unrealized gains are not fixed and can turn into losses in some cases. Tesla shares have lost more than a third of their value so far in 2022, demonstrating the risk lenders take when they allow Musk to use Tesla shares as collateral.

Possible solutions: For Americans who see billionaires like Musk access the value of their stocks without paying taxes, there are possible solutions to the problem.

A simple solution would be to prohibit the use of stocks as collateral for loans, but this sort of prohibition only makes sense if you view stock holdings as particularly unfair compared to real estate or debt. other forms of assets used as collateral.

Another potential solution would be to treat the loan as a taxable event, forcing shareholders to pay capital gains tax at the time the loan is made. This scenario would reestablish a new cost basis for the shares as if they had been sold and bought back at the current market price.

Photo: US Air Force Photo by Trevor Cokley, Public Domain, via Wikimedia Commons