Smart TaxesSmart Taxes

Profit from investing your home equity

You won't get rich, but tax laws will give you some profit -- if you make the right investments.

By Jeff Schnepper Feb 16, 2010 12:37PM

OK – I confess.

 

I like pushing the envelope, as long as I stay well within the sometimes elastic boundaries of fraud.

 

Here’s an idea that I like because it’s clearly legal and very simple to understand:

 

Borrow $100,000 secured by the equity in your home. The interest on a home equity loan of up to $100,000 is deductible. The IRS doesn’t care what you do with the money.

 

Let’s assume you borrow $100,000 at 5%. You pay interest of $5,000. But, if you’re in the 35% bracket, your tax bill shrinks by $1,750. So, you’re really only out of pocket $3,250.

 

Now take that $100,000 and invest it in a stock with a 4% dividend yield. That puts only $4,000 in your pocket.

 

But, qualified dividends are taxed at a maximum 15% rate. That leaves you with $3,400 after tax, at a cost of only $3,250.

 

Even with a yield 20% lower than the interest cost, you’re still ahead.

Now, we’re not talking big dollars here. But any difference between your marginal tax bracket and the current maximum 15% tax rate on qualified dividends and long-term capital gains provides a cushion for potential losses. It also leverages and magnifies potential gains if your actual yield is greater than the interest cost.

 

Want to maximize your spread? Borrow home equity qualifying dollars and use them to fund either a Roth IRA or a Health Savings Account. You still get to deduct the interest on the loan and any qualified earnings in the Roth or HSA come out completely tax-free.

 

But, there’s a downside. You have to make the right investments. The difference between 35% and zero makes a nice jingle in your pocket. But, that’s only if your investments don’t tank.

 

Related reading:

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