Capital Gains taxes

The other day we had a pretty interesting discussion here regarding Capital Gains taxes.

Anyway, my uncle was visiting today and he used to work at Bank of America in their investment management area. He talked about how ridiculous the capital gains tax system is (he’s conservative but thinks capital gains taxes need to be thrown out and replaced with something less easily gamed).

The example he gave is that if you pull a slot machine and win money, you’re taxed at your normal tax rate. If you pull the slot machine and it takes 1 year and 1 second to come up and you win, you could argue that it should be taxed at the capital gains rate (it wouldn’t really hold up, he was just illustrating a point).

I was wondering what the views of others on this is and what they would do, if they were emperor, about it.

If I were emperor?

Probably abolish capital gains as a concept and tax it as income, including unrealized gains that are used as collateral or transacted in any fashion.

You’re a dangerous man, Aaron. ;)

I wonder what % of Americans even think about unrealized gains.

Unrealized gains plus borrowing at libor +1 is one of the strategies I’ve learned from Buffet that Emperor Aaron would close down.

It’s one of the many reasons why I would never be elected to public office in this country outside of the most radically leftist of municipalities. :)

Treat at as income, but inflation-adjust the cost basis?

Heh. Well, most of my friends I hang out with would probably consider you a right wing nut. ;) Wish you lived in Michigan. We have much to discuss. lol.


Stop talking about unrealized gains. Look away people. ReptileHouse has nothing to show you.

Are we talking about unrealized unrealized or realized unrealizeds? Do we realize which are which?

Sorry, sometimes I can’t help but make a bad Rumsfeld joke. :)

Also, tentatively anyway, I wouldn’t explicitly adjust the gains for inflation. I think a pretty strong case can be made that such adjustment has already been made implicitly as part of the growth of the investment. At least in the case of dividends, stock gains, and such. It’s perhaps a tougher sell on something like bonds.


Ok, for those not familiar with this let me explain how people like Buffet (and guys like me to a far lesser extent) do things:

I invest a few million in a various set of funds which net out around 8% a year.

Until I cash those in, they’re not taxed. This is important. They’re unrealized gains.

But using those funds as collateral, I can go to the bank and borrow at Libor+1 (around 1.8% last time I checked) to invest in projects.

Assuming my investments do better than 1.8% per year (typically 7% per year) then I end up ahead.

This is what Buffet and lots of other people do.

But the evil evil AaronSofaer, whose name will exist only in the halls of hell for all eternity (and let’s take a moment to be honest here, he knows this already), if he were emperor, he would tax these unrealized gains.

This is what makes the “Bufffet rule” such a joke because Buffet’s “rule” is, in reality, based on making money on unrealized gains.

This is something the average person can’t realistically do and it’s the game that “rich” people play all the time that flies under the radar of nearly everyone.

Would you then have to have some mechanism to credit unrealized gains that eventually ended up as losses? I am sure it happens.

I would also favor taxing capital gains as regular income, probably because it wouldn’t have much effect on my bottom line.

You tax the amount of the loan, not the unrealized gain itself. Effectively, you’re making the act of taking out the loan a realization of the gain and resetting the cost basis of the investment itself.

Also, thanks for breaking that down so neatly, Brad. Very handy summary.

One thing I haven’t really been clear on, though, is what sorts of constraints there are on how one could get a LIBOR loan and what the money lent could be used for. I’ve never tried to use this particular trick myself, so all my knowledge is second hand and gets pretty vague on the details.


Under current laws wouldn’t the whole thing be a write off? The interest anyway would be deductible someplace.

I don’t know. Good question.

OK, what would be the economic impact of eliminating the unrealized games at libor? I’d need to know what that exactly would be.

Do any countries not tax capital gains separately?

As far as I know, only Australia and Russia (although Hong Kong can hit employees with vesting share options with a hefty tax bill).

FWIW, vesting RSUs are taxed as (with some hand waving) regular income in the US as well. The cost basis is then set at that level (again some hand waving) for when they’re later sold.

Stock options are not taxed at all until they are exercised, but when they are, it’s not capital gains, as you never owned the shares until then, just the right to purchase them. The tax hit when exercising options… hurts. A lot. Holy crap it hurts.

On average it’s factored into the price, but the mechanism is very crude. Unexpected inflation deltas are just flat-out losses. An explicit cost adjustment phased in over a decade or something for new holdings would be significantly efficiency-enhancing, I think.

That could very well be. It’d be important to be really careful in the details, as adding explicit adjustments for this, and that, and the other thing over there can easily lead to a big mess of exploitable loopholes once the process gets into political “make the sausage” territory. As a result, I’m a bit gun shy, even if it is theoretically more efficient, that it will turn out that way in practice.

Depends on qualified vs/ non-qualified.