> Generally, in exchange for such favorable terms (i.e., interest-only, matures on death), the bank will ask for a share of the collateral’s appreciation (essentially, "stock appreciation rights"), and this obligation will be settled upon the borrower’s death along with the loan. The amount of the bank’s share of the collateral’s appreciation depends on many factors and it is fundamentally a matter of the bank’s underwriting process.
Ok, so now the costs are the servicing of the loan for 40 years, and paying some percent of the appreciation. Is there any indication that this would be cheaper than just paying the $17M in taxes?
Mmm, I think we're mixing up some numbers here. Let me try to break this down for clarity.
Using the numbers in the report, the $17M in taxes would be paid after just 10 years, not 40 years, because the asset appreciated from $50M to $108M in 10 years and the buyer wanted liquidity at that point. After 35 years, the FMV of the asset is $740M, and tax liability would be (740 - 50) * 1/(20 + 3.8 + 5) = $198.72M
So, the question is not whether it would be cheaper than paying $17M in taxes, but whether it would be cheaper than paying ~$198M in taxes.
A couple of other things:
1) it's not clear they are taking out a loan against the asset. The report uses line of credit interchangeably with loan. If it's just a line of credit then they are only paying interest on the credit they use not the full loan amount upfront.
2) loan/LOC allow the capital to be liquid while continually having exposure to appreciation. This is valuable in itself because otherwise you have to make a choice between having exposure or remaining liquid. It's challenging to put figures to this aside from the obvious statement that a liquidation event results in a loss of 8% compounded YoY appreciation. This can be partially mitigated by repurchasing cheaper assets at the cost of some of the liquidity.
The report says:
> I’ve seen anywhere from 0.5 percent to 3 percent, even in the current interest rate environment
So, in the scenario where one takes out a loan for $97M at 3% interest after an asset of $50M appreciates for 10 years, if we assume that provides sufficient liquidity for the borrower to not take out subsequent loans during the following decades, then after 25 additional years the borrower would have paid ~$41M in interest. At 0.5% they'd pay ~$6M.
In an alternate scenario, if we assume the borrower takes out a loan for 90% of equity at 10 years, 20 years, and 30 years, then at 35 years they would have paid $127M in interest on a 25 yr loan + 15 yr loan + 5 yr loan at 3%. At a 0.5% interest rate they would have paid just $20M in interest.
All these scenarios are less than the $198M in taxes they'd owe while also giving them 8% exposure.
I do not have figures for how much the bank gets. My assumption is that they would negotiate terms where the interest rate is lower if the bank receives more of the asset or vice-versa. There's no reason for the loan recipient to take the terms if it's bad value for them relative to paying taxes at time of liquidation.
On the whole, I think the report makes sense as a reasonable approach for avoiding excess taxation.
The idea that anyone is getting a 0.5% interest rate for anything—let alone with collateral of a risky asset—when treasuries are at 4%+ is fanciful, and makes me lean strongly in the direction of the LARPer theory.
People didn't believe negative interest rates were possible either.
Anyway, I bet at that level of loan the customer has a lot more power; no lender is going to want a billionaire to do their business elsewhere. The human lender who signs the loan gets a promotion for increasing the bank's future-money. And if it goes sour, that human won't lose money. Even the bank doesn't need to worry about its existence if it will be bailed out by the tax payer anyway.
I mentioned it at the bottom. The report doesn't provide numbers. I would assume that they would negotiate a rate that results in marginally higher yield than a bond that would mature over the lifetime of the loan.
30 year bond is ~4.2%. You'd pay $60M in interest on a single loan at 10yrs and $183m if you took out repeated loans at 10yr/20yr/30yr and repaid at 35.
I assume that the math works out such that if you had a LOC for 100% of the asset, at the 30 year bond rate, and continually maxed out the LOC, that the interest rate paid would equal the taxation rate.
The point is that the worst case scenario is paying equivalent fees without having to trade-off between liquidity and appreciation and the best case scenario is significantly lower fees because you didn't need 100% liquidity.
I'm going to bring up a point here that no one else is making because they mistakenly believe this to be about taxation.
So firstly I use this strategy. I am not anywhere near $300M in net worth but anyone can do this with a few hundred K in stock and a margins account at IBKR.
Anyway, the reason has nothing to do with tax and everything to do with cash. Cash is dangerous. Once you have cash, the value can decline. On the other hand equity in actual companies is always going to have value. Companies like coca cola, Johnson Johnson, etc provide necessary things. They will always have cash flow regardless of how the dollar is doing. Equity is a huge inflation hedge. For me personally I was unaffected by inflation because stock prices inflated as revenues increase anyway. Cash is dangerous.
If you sell equity, it can be difficult to buy back in. Instead it's better to borrow. The equity will eventually go up and you can borrow more. Also, borrowing is instant, whereas selling is volatile as huge dumps of shares can easily manipulate the price on the open market.
Either way, you de-risk not being exposed to equity, which is a valuable store of income. Cash is an extremely dangerous way to store value, in my view, and I'm guessing many of these people.
I’m unsure how to compare a cost paid after I die to one I pay now. Is that my cost at all? It seems like a philosophical question. I guess it depends on how much you care about your heirs.
The reddit post claims the inheritors get to avoid taxes. If that is false, the reddit post is a lie, nothing philosophical about it. It does not depend on anything.
Yeah, I felt like the “you have to be wealthy” hand-waving in the quoted section wasn’t very explanatory. Are lenders giving the ultra-rich great interest rates here as a loss-leader to try to attract other business from them?
> First, this type of planning is generally not economically feasible unless the taxpayer has a net worth exceeding around $300M. If you’re worth less than that, you’re not going to be able to command attractive loan/line of credit terms from investment banks. You’re going to have to get a plain vanilla product from a retail lender which is going to have relatively high interest rates (typically the Secured Overnight Financing Rate plus some amount of spread) and other terms that make implementing “buy, borrow, die” expensive enough that you aren’t much better off (or you’re much worse off) than you would have been had you sold the asset and taken the after-tax proceeds. (Caveat: even loans/lines of credit at retail interest rates can still be very useful for short-term borrowing needs.) Clients with a net worth exceeding around $300M, however, can obtain bespoke products from the handful of lenders that specialize in this market, and the terms and conditions of these products make “buy, borrow, die” a no-brainer for virtually everyone who has this level of wealth.
It's an investment for a bank which is middle way between regular loan/bond (where you get fixed interest and 100% of the loan at the end, but no appreciation) and stock share (where you get no fixed interest and all the appreciation when you sell it). The hybrid product would be you get some interest and some of the appreciation, but not as much interest as for a loan, and not all the appreciation at the end. How much would obviously be negotiated depending on interest rates, projected appreciation, and other factors. The point here would be to defer paying the interest (to make the asset owner's life easier while they are alive) while leave enough enticement for the bank to agree to the whole scheme (banks usually don't just buy shares in people's 401k's). I do not know which combination specifically works but it doesn't seem implausible for me for such combination to exist.
The lender gets to write a secured loan with an excellent risk profile and an interest rate that, on average, generates net profit that is at least as good as other lending opportunities.
From the lender's perspective this is a relatively straightforward transaction. A lender will lend to just about anyone if the spreadsheet numbers work out.
Is it really that good of a risk profile? Some of these assets they are writing against are pretty volatile. I would not write a low interest loan against TSLA shares or commercial office buildings.
What do you think the borrower did with the $hundred-M that they borrowed?
There's only so much you can blow on intangibles. Should there be a major write down in the value of the asset, chances are not bad that there are tangibles to reclaim.
In addition to other responses, and if the lender is a bank, and given a fractional reserve banking system - it's possible that the lender doesn't actually pay the amount loaned out of their own assets. It just counts against the amount which, multiplied by the reserve fraction, must be backed by a reserve. So assuming a fraction of 1/10, it is somewhat as though they had loaned out a tenth of the money the lender actually gets.
