Why Can Billionaires Avoid Taxes On Stocks But Use Them As Collateral For Loans?

"Daily Show" host Trevor Noah recently criticized the tax laws that allow billionaire Tesla Inc. TSLA CEO Elon Musk to borrow money tax-free using his Tesla shares as collateral to fund his $44 billion proposed buyout of Twitter Inc TWTR.

Noah argued there's a contradiction to the idea that unrealized gains in stock holdings are not eligible to be taxed but can be used as collateral, seemingly providing billionaires such as Musk access to unrealized stock gains 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 of the illogic of it. It's such a fun game that billionaires get to play because all their money is in [the stock market]," Noah said.

Related Link: Here's What Warren Buffett Thinks About Tesla And Elon Musk

Stock Collateral Loans: The U.S. tax code only taxes investors for capital gains, gains on shares of stocks and other investments, and when they sell the shares. The IRS considers asset sales "taxable events." Unrealized gains, gains in the value of a stock or other asset prior to being sold, are not taxable because the owner doesn't have access to that value until the asset is sold.

Stock collateral loans allow investors to use their stock as collateral without selling those shares. These loans are a way billionaires can take advantage of the value of their stocks and other assets without actually selling them and triggering a taxable event. This principle is the same idea many Americans take advantage of when taking out home equity lines of credit. A house sale is considered a taxable event, but Americans can borrow against the value of their house if its value rises, even if they do not sell the house or pay taxes on the unrealized gains.

One reason assets are not taxed based on unrealized gains is because unrealized gains are not fixed and can transition to losses in certain cases. Tesla shares have lost more than a third of their value so far in 2022, demonstrating the risk lenders take on when they allow Musk to use Tesla shares as collateral.

Possible Solutions: For Americans who see billionaires such as Musk accessing the value of their stock holdings without paying taxes, there are possible solutions to the problem.

One simple solution would be to ban the use of equities as collateral for loans, but this type of ban only makes sense if you see stock holdings as uniquely unfair compared to real estate or other forms of assets used as collateral.

Another potential solution would be to treat the loan as a taxable event, forcing shareholders to pay taxes on capital gains at the time at which the loan is made. This scenario would re-establish a new cost basis for the shares as if they had been sold and repurchased at the current market price.

Photo: U.S. Air Force photo by Trevor Cokley, Public domain, via Wikimedia Commons