The “buy, borrow, die” strategy is a popular estate planning tool that many wealthy people use to minimize the amount of taxes they owe on their investments. The basic idea is to purchase investments that appreciate in value, borrow against these assets and use them as collateral for loans, and then pass on these assets to heirs once you die. By using this strategy, the wealthy position themselves to minimize their tax burden and build generational wealth.
As the old saying goes, the rich get richer, and the poor get poorer. And in today’s economy, that gap is only widening. One of the reasons for this is that the wealthiest individuals in our society often manage to avoid paying taxes on their income. This is accomplished through various methods; the “buy, borrow, die” strategy is a popular one.
The wealth of many high-income individuals usually comes in the form of gains in the value of appreciating assets, and they can avoid taxes on those gains if they hold on to their assets rather than sell them. As a result, some of the nation’s wealthiest individuals pay little or no income tax each year while still being able to afford a lavish lifestyle.
How the “buy, borrow, die” strategy works
The phrase “buy, borrow, die” was created by Edward McCaffery, a tax law professor at the University of Southern California Law School to describe how the rich benefit from the American tax system.
However, you don’t have to be wealthy to learn or use about this technique. Let’s take a look at how this strategy works, so you know how the game is played.
To benefit from the “buy, borrow, die” strategy, you must first buy appreciating assets such as real estate, bonds, or stocks, and then hold onto them for the long term. Avoid investing in assets that are volatile or are likely to depreciate in value like investing in a questionable startup, purchasing a car, or buying cryptocurrency.
Once you own an appreciating asset, the next step is to borrow against it.
Typically, when you need money, you’d sell your asset to generate cash. But doing so would trigger the capital gains tax. To avoid paying taxes, you can use your assets as collateral to get a loan from the bank at a low interest rate. By not realizing the gains, you allow your assets to continue to grow in value, while still getting cash without triggering a taxable event.
Another perk of this strategy is that you don’t pay taxes on the loan proceeds. Plus, loan interest rates are typically much lower than income tax rates.
According to ProPublica, in 2021, Elon Musk pledged around 92 million Tesla stock shares (worth approximately $57.7 billion as of May 29) as collateral for personal loans. So instead of realizing his holdings and incurring substantial capital gains taxes, Elon Musk lives tax-free off his wealth by simply borrowing against his assets.
Similarly, Larry Ellison, Oracle’s chief executive officer, pledged part of his company stock as collateral for a $10 billion personal line of credit in 2014.
Lastly, you eventually die and pass on your estate to your heirs (or beneficiaries). This step is also where you establish generational wealth. Once the asset is sold off tax-free, your heirs can pay off the remainder of the loan with the proceeds of the sale.
For example, let’s say you bought a $2 million property 10 years ago. By the time you pass away, it’s valued at $5.5 million. If your heirs decide to sell this asset today, they’ll pay zero capital gains tax because of the step-up in cost basis loophole.
Simply put, because your heirs received the asset at a cost basis of $5.5 million, they’ll have no gains when they sell it at the property’s market value ($5.5 million). This step-up in cost basis can save your heirs a fortune in capital gains taxes (though they still may have to pay estate taxes).
Is the “buy, borrow, die” strategy legal?
Yes, the “buy, borrow, die” strategy is completely legal, and many ultrarich individuals have been using this strategy to help them retain as much of their wealth as possible. After analyzing IRS data on the tax returns of our nation’s 25 wealthiest people, ProPublica found that the true tax rate of these individuals was only around 3.4%.
For example, Warren accumulated more than $24 billion in asset value from 2014 to 2018. However, because a substantial amount of his wealth came from unrealized gains, Warren Buffet only reported $125 million in income during this period and paid $23.7 million in taxes.
Though Warren Buffet’s 0.1% true tax rate might seem ridiculously low, he didn’t actually break any laws. Instead, he simply took advantage of the tax code loophole that favors the rich.
What assets can you borrow against?
For the “buy, borrow, die” strategy to make financial sense, you’d want to borrow against assets that can appreciate more than the interest rate on the loan. Appreciating assets such as real estate and stocks are both viable choices. A car, on the other hand, would be a poor investment option since its value typically goes down over time.
However, make sure you choose your investments from the stock market carefully. If you don’t have a well-diversified stock portfolio in place, you may lose more money than you’d pay through taxes. If need some help choosing the appropriate investment, consider speaking with an investment advisor.
How can you use this strategy?
Though most of us might not be able to lower our tax rate to 3.4% like the ultrarich, we can still apply the “buy, borrow, die” strategy to our finances.
For example, rather than selling an appreciating asset like your home to make an investment or pay for a large expense, use the equity in your property to secure low-cost funds in the form of a home equity line of credit (HELOC) or home equity loan. Plus, you can deduct the interest on a HELOC or a home equity loan if you use the funds to renovate your home. And if the property is your primary residence, you can exclude up to $250,000 of capital gain from your income, or up to $500,000 (if you file a joint return) when you sell the house.
How do the rich live off loans?
The rich can often live a comfortable lifestyle by borrowing money against their holdings. The more their assets’ value grows, the more unrealized gains they have. An unrealized gain doesn’t mean it’s unreal; it just means the asset has not yet been sold and is untaxed. And by taking out a loan against their appreciating assets, the rich can essentially live tax-free off their growing wealth.
How do the rich avoid taxes with debt?
If the rich are already wealthy, why would they need to finance borrowed money to cover their living expenses? Well, for wealthy people who have achieved substantial capital gains, taking out a loan against their assets instead of selling them is a strategic way to avoid paying capital gains taxes. As long as they don’t sell their assets, they won’t incur taxable income.
So to avoid triggering a taxable event, rich people use these assets as collateral to borrow money through a credit line or loan with interest rates as low as 2%. In other words, the rich avoid taxes by using unrealized gains to finance their lifestyle.
Why is borrowed money tax-free?
The tax advantage of the “buy, borrow, die” strategy exists because you aren’t selling your asset for cash. Instead, you’re using the appreciating asset as collateral and taking out a loan against it. For this reason, you aren’t liable for capital gain tax. However, you are responsible for paying back the loan you’ve taken out.
- Many wealthy individuals use the “buy, borrow, die” strategy to minimize the amount of taxes they owe on their appreciating assets.
- The basic idea of the “buy, borrow, die” strategy is to first purchase investments that appreciate in value. Then you borrow against these assets and use them as collateral for loans before passing on these assets to heirs and establishing generational wealth.
- An unrealized gain is a profit you’ve made on an investment, but haven’t yet sold the investment. Instead of selling an investment for a profit and paying taxes on the gain, many wealthy individuals take out a loan against the asset to fund their lifestyle while avoiding hefty taxes.
- By inheriting an asset at its current market value, heirs can avoid paying capital gains taxes on the appreciation. This loophole is often used by wealthy families to minimize their tax liability.
View Article Sources
- ProPublica Shows How Little the Wealthiest Pay in Taxes: Policymakers Should Respond Accordingly — Center on Budget and Policy Priorities
- Topic No. 701 Sale of Your Home — IRS
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- What are the best options for parking huge amounts of money? Your Investment options. — SuperMoney
- What is Generational Wealth and How Do You Build It? — SuperMoney
- What To Invest In During War — SuperMoney
- Five Key Principles Of Smart Investing — SuperMoney
- How To Invest In The Stock Market: 8 Basic Concepts — SuperMoney
- Best Investment Advisors — SuperMoney
- Beginner’s Guide to Investing — SuperMoney