As critics continue to decry how the tax code favors the rich, wealthy people are continuing to prosper by using loopholes to avoid paying taxes. Though they are quite capable of purchasing real estate and other wealth-building assets outright, most wealthy people borrow money to finance such purchases and rarely if ever sell their assets.
In short, the wealthy don’t sell their stocks, bonds and real estate if they need cash. Instead, they just borrow from their private bankers or brokerage. They can build their wealth without taxes, while accessing the cash they need with relatively low interest loans.
Take billionaire Facebook founder Mark Zuckerberg for example. In 2012, Zuckerberg refinanced his Palo Alto home with a 1.05 percent adjustable mortgage, CNBC reported. The home cost $5.95 million at the time, which is “chump change” for Zuckerberg. But instead of buying it free and clear, he opted for a 30-year adjustable mortgage on the property, which was less than half the national average.
The reason: “It costs him absolutely nothing,” CNBC wrote. “When you can borrow at an interest rate that’s below the rate of inflation you’re essentially borrowing for free,” Greg McBride, a senior analyst at Bankrate.com. told CNBC. “When you can borrow for free, there’s no sense in tying up your own money, when you can use that money for more profitable things.”
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The caveat: These extremely low-interest rate mortgages are only available to super-wealthy people who are essentially no-risk borrowers. When Zuckerberg secured his 1% mortgage rate, the majority of Americans were paying 3% or higher.
Another strategy wealth people use to stay that was is avoiding capital gains taxes. “Capital gains taxes are a type of tax on the profits earned from the sale of assets such as stocks, real estate, businesses and other types of investments. When you acquire assets and sell them for a profit, the US government looks at the gains as taxable income,” according to bankrate.com.
There is a long-term capital gains tax and a short term capital gains tax. Any asset held for a year or more is considered as a long-term capital gains tax and thus eligible for a capped interest rate when an asset is sold. This rate ranges from 0% to 20%.
Since wealthy people know this, they hold onto their assets longer to avoid paying the capital gains taxes. One Twitter user, Ric Burton, explained it like this: “Rich people never sell their capital They borrow against it to avoid capital gains taxes This is something very few people seem to understand,” Burton tweeted.
The highest capital gains rate for the wealthy is 20% and some of the wealthiest people can borrow at less than 5-10% from their bank. The more wealth they have, the better interest rate they may be able to get based on the size of their assets/stock portfolios.
Wealthy people also often opt to get paid in stocks and dividends, while opting for a menial salary so the tax liability they owe on their income is lower. This is known as income modification.
“By incorporating and paying themselves a reasonable, smaller salary, the mega-rich can take a higher portion of their income as dividends. Dividend income is generally taxed at the same 15% to 20% capital gains rate,” Lexch.com reported. “Another tactic is to take a portion of compensation as stock options, which are generally taxed only when the options are exercised.”
Summarily, wealthy people hold onto their assets and borrow money to fund their lifestyles since they qualify for tax breaks and mortgage terms that ordinary working-class people do not. It’s how the rich get richer and the wealth gap continues to increase.
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