There’s a Way To Use The Money You’ve Made From Investments Without Paying Tax.
Apart from the obvious ways to make money from your investments without selling—dividends, rental income, staking/interest rewards (crypto)—there’s another, more tax-efficient way called securities-based lending.
Firstly, I’d like to say that I am not a tax professional. You should always consult a tax professional if you wish to follow this strategy. This is legal, but it has to be done correctly, and I can’t explain every detail within this thread. This is not financial advice.
Taking out securities-based loans (borrowing against your stock portfolio) is a strategy that the ultra-wealthy have been using for a while now—and for a good reason: you can use the money you’ve made from your investments without selling and without paying tax.
Take billionaire Elon Musk, for example, who has used this method to attribute to his close to $0 in taxes in multiple years. Musk currently has $548m in securities-based loans from various banks.
It’s only recently been available to regular investors with brokerages like M1 Finance, Wealthfront, and Interactive Brokers offering securities-based lending. As a result, and with interest rates so low, dismissing this strategy without looking into it more would be unwise.
Why it’s beneficial: an obvious but little-known observation is that, unlike income, debt is tax-free. Taking a loan out means that you can save on capital gains taxed (owed whenever you sell an asset for more than you paid for it).
You could, in theory, take a $1,000,000 loan against your portfolio, go out and spend that money and pay 0% in tax. Better yet, you could use the loan to purchase an asset that produces a higher return than the interest rate on the loan.
To make $1,000,000 to spend or invest it, you’d need an income of around $1.6m—and that’s assuming no state or local taxes.
How it works: brokerages/banks offer you a loan (using your stocks as collateral) based on your portfolio value. This is usually done through a taxable brokerage, not a retirement account.
The loan usually carries a low-interest rate because it is seen as low-risk to the lender as you’ve put up collateral (your investments). This means that if you fail to make payments or your investments tank, the lender can sell your stocks and recover their principal + interest.
How you pay the loan back: there are two main ways to solve this problem. Most brokerages/banks usually offer securities-based loans as a perpetual loan, meaning you don’t need to pay back the principal. This means that you’ll only need to make interest payments.
You can do this by selling shares, using dividends, rental income, or your 9-5 salary (all taxable events). You can avoid tax altogether (situation dependable) by solely using your tax-free capital gains allowance ($80,000 a year for a married couple) to make interest payments.
Alternatively, you can avoid tax altogether by refinancing your loan every few years. Assuming your portfolio value rises over time, you can take out another loan and use that to make interest payments/pay down the old loan. Repeat this indefinitely to defer tax.
Risks: it goes without saying, but this strategy uses leverage (debt) and can be extremely risky if you are overleveraged. The bank/brokerage also has the right to demand you repay the loan without reason which could be detrimental if you don’t have the cash to repay it.
You may have to (or the brokerage may have to) sell part of your portfolio; an unwanted taxable event. To reduce risk, take a loan value no more than 40% of your portfolio; the lower, the better.
As I’ve said previously, it would be unwise to ignore this strategy because it could potentially save you hundreds of thousands in taxes while taking on minimal risk if done correctly.
That’s it! Please remember that this is not financial/tax advice.