Using Credit to Reduce Tax Liability

Oct 4, 2020

If you've had some time to build up your savings you've probably done the smart thing and invested a substantial portion in the stock market. If you've accepted a job at a public company within the last four years, you're also likely to have accumulated some of the company's stock as a part of your compensation. Hopefully this has gone well for you! As I am writing this the S&P 500 is up about 30% over the past three years.

If this describes your situation, congrats! But, what happens if you have a large unexpected expense? Many would have to sell a portion their portfolio to cover an expense beyond a couple thousand dollars, and as the expense increases, that means an increasing tax liability for any pending capital gains. Unfortunately, the large balance number in your brokerage account isn't actually accessible to you in many cases, because the government steps in and claims a portion of it. (This is usually between 15% and 35%!!)

Thankfully, there are ways to mitigate this using loans. Imagine you want to sell your car, but you've still got a loan of $18,000 on it that you'd like to pay off first. You know you'll get roughly $18,000 back when you sell the vehicle, but you need the cash up front to make the transaction. If you were to sell stock with as-yet-untaxed gains, you could pay a steep penalty. A great option you have here is finding a lender and explaining your situation. Offer to pay them a substantial interest rate (perhaps 7%?) for a short term loan to cover your car lien, and show them that your brokerage account has more than enough money to cover the amount of the loan. They should perceive the loan to be relatively low-risk (since you have the money) and high-reward. Borrowing against your brokerage assets is not a taxable event, so in this situation you end up paying your lender 7% APR for a couple months instead of paying the IRS 15-35% of your gains.

This is great, because instead of paying taxes and re-investing once you get the money from the car sale, which would leave you with a lower brokerage balance, you simply pay your friend a few hundred dollars once you sell the car. A few hundred dollars in interest is a far better option than thousands in taxes.