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Loans against stock aren't taxed
Borrowing instead of selling
Picture a million dollars of Facebook stock. A bank lends 500k in cash against it, the owner keeps the shares, and there is no tax to pay on the borrowed cash. If the stock climbs to 2 million, the owner can go back to the bank for another 500k.
The risk on the way down
The risk sits on the way down. If the stock falls, the bank issues a margin call, and the owner has to come up with cash or the shares may be sold after the drop. It is not risk-free.
The same rules apply to anyone with a large holding, including an S&P 500 index investment. Borrowing against risky assets carries a lot of risk, whoever does it.
Why is borrowing against stock not taxed?
US tax law taxes gains when they are realized, typically on a sale, a principle that goes back to the 1920 Supreme Court decision in Eisner v. Macomber. A loan is not income because it must be repaid, so borrowing against shares triggers no realization. The shares stay in the owner's hands, and any gain remains untaxed until a sale.
Why can margin calls force sales at bad times?
A lender holding shares as collateral requires the loan to stay below a set share of their value. When prices fall, that ratio breaks, and the lender can demand more cash or sell the shares without waiting. Many borrowers face the same demand at the same moment in a downturn, which pushes prices lower. In US brokerage margin accounts, Regulation T lets investors borrow up to 50 percent of a purchase.
How did margin lending shape the 1929 crash?
Before the 1929 crash, brokers' loans to customers reached about $8.5 billion, and buyers often put down only 10 to 20 percent. When prices fell in October, margin calls forced selling that pushed prices down further. The Securities Exchange Act of 1934 gave the Federal Reserve authority to set margin requirements.
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