Taxing Unrealized Gains
How do you pay tax on something you haven’t sold yet?
This week our friend’s south of the border in the States were reporting that if Vice-President Kamala Harris were to win the election, she would implement an unrealized capital gains tax.
Just to refresh. If you buy something for $10 and sell at $20, you have a capital gain of $10. An unrealized capital gain is if you buy something at $10 and it is now worth $20 and you have not sold, you have an unrealized capital gain of $10. The unrealized capital gains tax would tax that unrealized gain without you having sold it.
In response to all this I tweeted out the following:
From a tax perspective, it would be interesting to see how a government would implement this. You don’t actually have the money to pay the tax unless it is sold. However, a lot of wealthy individuals just take out loans against their unrealized gains and live off of that (called the buy, borrow, die strategy). If someone buys something for $100 and it is now worth $200m, you can go to the bank and take out a loan against the value of that 200m for say 100m. This 100m is effectively free money as it is just a loan. Sure you have to pay interest on it but the 100m you have access to is non-taxable because you still haven’t sold anything yet.
However, billionaire Bill Ackman had this to say the about that borrowing method:
I think this would be a really fair outcome. If you have a very large unrealized capital gain and use a loan to access that gain, you would be taxed on this. The amount that you borrow would then be your new cost basis for the loan. Then that leads to the problem of what about all of the people who are currently borrowing against assets? Do they automatically get taxed now? Or just individuals who do it on a go forward basis?
It’s an interest topic to discuss and I have the following questions and comments about taxing unrealized gains:
Most governments encourage investing in entrepreneurship and businesses but this would increase the tax burden on saving and investment. The whole point of paying lower tax rates on capital gains is to encourage investing.
How would the value of something that is private or not tradable be calculated? Is it up to the government to calculate the value or the individual?
If someone owns illiquid assets and now has to pay tax having not sold the asset, what if the only money they can obtain to pay the tax is thereby selling the asset itself? This could lead to forced sales where the seller won’t get fair market value because they have to sell to pay the tax and everyone knows it.
Each year if your investment grows will you constantly have an unrealized gain tax or is it over a period of years?
How would unrealized losses be treated? If I paid tax on an unrealized gain but that gain is now a loss, what I be refunded? Who would track all of this?
What type of investments would it apply to and is it just the “ultra wealthy” or would it apply to everyone?
How do tax-avoidance strategies like using trusts have a role in the future? Or would these vehicles be subjected as well?
This is an area that will be interesting to follow and if implemented, to see if other countries follow suit.
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