The Taxable Investor's Manifesto

CHAPTER THREEGenerate Value from That Magical Liability: Deferred Tax

Most of us start our careers with no equity ownership, no profits, and no deferred taxes. As we build savings, we have the opportunity to invest. Successful investments, whether in a diversified portfolio or in a concentrated position, will experience a widening gap between their cost and their market values. A component of that gap is deferred tax that will have to be paid to the government upon sale of the asset. Deferred tax liabilities may feel amorphous, but they are really good, maybe even a touch magical.

To quote from my first book, Wealth:

It's like getting no-interest loans from the government! It also has some other attractive features. First, at no point does the government have the authority to say, “We are calling your loan.” You have the right to let the free “loan” continue unpaid for as long as you want, so long as you don't sell the underlying asset. Second, in most cases, the size of the loan varies proportionately with the success of the investment. The bigger the gain, the bigger the loan.

It's easiest to understand the power of deferred tax through the example of a single equity position in a successful business. So long as you hold that equity position, it doesn't generate realized capital gains and taxes are deferred year after year. The longer you hold it, the more you defer the tax liability associated with selling. If the company is growing in value, the associated deferred tax ...