When Can Borrowing Save You Taxes?

A client we’ll call “Joe,” owns several family-style restaurants in Southern California. Joe was recently contacted by a friendly competitor. The competitor was ready to retire and wanted to quickly exit the business. A very attractive, discounted price was offered to Joe, but he had to act quickly to get the discount and avoid having other potential buyers compete with him. Joe was considering selling a significant amount of securities to fund the purchase price.

Joe’s annual income puts him in the 20% Federal long-term capital gains tax bracket (> $425,800 for a single individual in 2018). So, not only would he pay the capital gains tax of 20% if he sold the securities, he would also have to pay an additional 3.8% tax on any gain above $200,000 ($250,000 if married). And, by the way, California treats the taxable gain as income with a tax bracket of 14.63% on any gain of $1 million or greater. Understandably, Joe was leery of selling the securities because he did not want to pay the combined ~36% tax. There were several alternatives we proposed, but today we’ll talk about one that is missed by most advisors, including sharp tax advisors. Joe used this method to obtain the funds and purchase the restaurant within three days, all without paying the collective 36% tax.  So – What Did He Do? 

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