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If I need $x as cash, I can borrow from a bank, using some stocks I own as collateral. Thus I receive $x cash which is not subject to taxes.

When the time comes for me to return what I've borrowed, I can refuse, and the bank will seize my stocks. Most likely the bank would prefer to cash out, so the bank will sell the stocks and get $x.

Will the bank be taxed on the $x received through selling the collateral?

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    I am sure that the loan agreement is structured so that you are deemed to have sold the shares (since you own the shares) and have paid off the loan, with any capital gains (or losses) on the sale being assigned to your taxable income, and have paid off the loan. The $x is not taxable to the bank -- it is a return of their loan -- nor to you, only the capital gain on the sale, if any. If the collateral is worth less than $x at the time of foreclosure, the bank will come after you for the balance due after selling all the shares and getting back part of the principal amount. – Dilip Sarwate May 27 '13 at 13:24
  • I very much doubt the bank would pay any taxes, as they haven't gained anything. If you default on the loan, then they have lost the value of the loan and gained the stocks. In the event that they sell the stocks for more than the loan value, they probably owe you the balance (less any fees they decide to charge for processing your default). – DJClayworth May 29 '13 at 15:38
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If you are planning this as a tax avoidance scheme, well it is not. The gains will be taxable in your hands and not in the Banks hands. Banks simply don't cash out the stock at the same price, there will be quite a bit of both Lawyers and others ... so in the end you will end up paying more.

The link indicates that one would pay back the loan via one's own earnings.

So if you have a stock worth USD 100, you can pledge this to a Bank and get a max loan of USD 50 [there are regulations that govern the max you can get against 100].

You want to buy something worth USD 50.

Option1:
Sell half the stock, get USD 50, pay the captial gains tax on USD 50.

Option2:
Pledge the USD 100 stock to bank, get a loan of USD 50.
As you have not sold anything, there is no tax.
Over a period pay the USD 50 loan via your own earnings.
A high valued customer may be able to get away with a very low rate of intrest and very long repayment period.

The tax implication to your legal hier would be from the time the stock come to his/her hands to the time she sold.
So if the price increase to 150 by the time Mark dies, and its sold at 160 later, the gain is only of USD 10.

So rather than paying 30% or whatever the applicable tax rate, it would be wise to pay an interest of few percentages.

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  • Hmm, so what does the article nytimes.com/2012/02/08/opinion/the-zuckerberg-tax.html?_r=0 mean when it talks about using stocks as collateral to borrow against wealth and avoiding tax? – Pacerier May 29 '13 at 6:46
  • Updated the answer. – Dheer May 29 '13 at 9:15
  • Do you know roughly how long will (was) he able to borrow? If he borrowed for 40 yrs, and after 40 yrs he is still alive, Wouldn't he lose out then? (since he need to pay both the interest and no less on capital gains) – Pacerier Jun 20 '13 at 8:24
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Will the bank be taxed on the $x received through selling the collateral?

Why do you care? They will, of course, although their basis will be different. It is of no concern for you.

What is your concern is that the write-off of the loan is taxed as ordinary income (as opposed to capital gains when you sell the stocks) for you.

So when the bank seizes the stocks, they will also report to the IRS that they gave you the amount of money that you owed them (which they will "give you" and then put it on the account of the loan). So you get taxed on that amount as income.

In addition, you will be taxed on the gains on the stocks, as giving them to the bank is considered a sale. So you may actually find yourself in a situation where you'd be paying taxes twice, once capital gains, and once as ordinary income, on the same money.

I would strongly advise against this.

If it is a real situation and not a hypothetical question - get a professional tax advice. I'm not a professional, talk to a CPA/EA licensed in your state.

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The short answer is that the exchange of the stock in exchange for the elimination of a debt is a taxable exchange, and gains or losses are possible for the stock investor as well as the bank.

The somewhat longer answer is best summarized as noting that banks don't usually accept stocks as collateral, mostly because stock values are volatile and most banks are not equipped to monitor the risk involved but it is very much part of the business of stock brokers.

In the USA, as a practical matter I only know of stock brokerages offering loans against stock as part of the standard services of a "margin account". You can get a margin account at any US stock broker. The stockholder can deposit their shares in the margin account and then borrow around 50% of the value, though that is a bit much to borrow and a lower amount would be safer from sudden demands for repayment in the form of margin calls.

In a brokerage account I can not imagine a need to repay a margin loan if the stocks dividends plus capital appreciation rises in value faster than the margin loan rate creates interest charges...

Trouble begins as the stock value goes down. When the value of the loan exceeds a certain percentage of the stock value, which can depend on the stock and the broker's policy but is also subject to federal rules like Regulation T, the broker can call in the loan and/or take initiative to sell the stock to repay the loan.

Notice that this may result in a capital gain or loss, depending on the investor's tax basis which is usually the original cost of the stock. Of course, this sale affects the taxes of the investor irregardless of who gets the money.

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