Berkshire Hathaway Saves Billions With Capital Gains Tax Strategy

(BRK.A), (BRK.B)

Investing in Berkshire Hathaway is often compared to investing in a mutual fund. Yes, Berkshire’s ownership of GEICO, BNSF, McLane, Lubrizol, Berkshire Hathaway Energy, Dairy Queen, Fruit of the Loom, and a host of other companies certainly give it a lot of diversification. Its ownership of the Marmon Group, which alone encompasses 160 separate companies, means that people almost on a daily basis come in contact with Berkshire’s products, often without knowing it.

However, there is an interesting difference between Berkshire Hathaway and a mutual fund, which directly impacts its shareholders. The difference is Berkshire’s ability to avoid capital gains taxes through asset acquisitions.

Berkshire Hathaway, unlike a mutual fund, is all about the buying and owning of whole companies. And while a mutual fund can own a portion of a company, its later sale of appreciated shares in that company generates a capital gain that is passed through to the mutual fund’s shareholders.

It is in this area that Berkshire has demonstrated a key advantage. In 2014 alone, Berkshire avoided capital gain taxes on $2.357 billion of appreciated stock by swapping its shares of appreciated stock for business units to add to its conglomerate.

Berkshire’s acquisition of Graham Holding’s WPLG-TV, Phillips 66’s pipeline-services business, and Procter & Gamble’s Duracell battery unit all enabled it to cash in billions of dollars of appreciated stock without capital gains taxes.

There’s More to the Story

While these acquisitions added new units to Berkshire’s portfolio, they also served as a conduit for bringing in cash tax free, because the companies that were acquired had sizable cash positions on their books.

In the case of Duracell, Berkshire’s $4.7 billion stake in Procter & Gamble came from an original investment in Gillette of only $600 million. In cashing out its position, Berkshire not only gets control of Duracell, but Duracell has been recapitalized by P&G with $1.7 billion in cash. This equivalent of leaving a very large bag of cash in the desk drawer in Duracell’s president’s office, allows Berkshire a transfer of cash that is three times its original investment in Gillette, and the entire $4.7 billion transaction incurs no capital gains taxes.

Similarly, the acquisition of Phillips Specialty Products Inc. from Phillips 66 included approximately $450 million in cash. Berkshire’s acquisition of WPLG-TV, which was part of the unwinding of Berkshire’s position as a shareholder in the Washington Post, also brought to the company roughly $328 million in cash and $444 million Berkshire shares that had been owned by Graham Holdings. In this case, Berkshire avoided substantial capital gains that would have been owed on its original $11 million investment in the Washington Post.

Over the years, Warren Buffett has been shrewd in getting into stock positions that have generated amazing appreciation. Berkshire’s $16 billion stake in Coca Cola, on a cost basis of only $1.29 billion, is just one example. And it should be recognized that his ability to liquidate positions without capital gains consequences has been equally shrewd.

So, the next time you are looking at your end-of-year mutual fund statement and wondering why you have to pay capital gains, even though you didn’t redeem any shares, just think of the tax free acquisitions that have saved Berkshire’s shareholders billions.

© 2015 David Mazor

Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.