Avoid capital gains taxes like a billionaire using ‘buy, borrow, die’ strategy (2024)

Often, after speaking about taxes at a medical conference, we are approached by a physician attendee who has read that billionaires, like Warren Buffet and Elon Musk, pay less taxes than they do and they wonder how that can be.

Typically, the physician then asks how they can do what the super-rich do in this regard. In this article, we examine the “buy, borrow, die” strategy that billionaires use to avoid capital gains taxes and explain tactics physicians can use to do the same thing.

The name of this strategy comes from this quote from Edward McCaffery, a University of Southern California law professor: “Once you’re already rich, it’s simple, it’s easy. It’s just buy, borrow, die. These are planks of the law that have been in place for 100 years.”

We will examine each piece of the strategy briefly and discuss four ways physicians can also make use of the strategy.

Buy

For many billionaires, this means create startups that become huge companies. However, for physicians, this can also mean “save and invest.”

Any action that creates assets on your balance sheet will work. Once you have an asset, you can then move to the next step.

Borrow

This simply means borrowing funds using the assets as collateral. Loan proceeds have never been taxable under our tax code. By borrowing, you can get access to cash without paying any tax. As an example, let’s assume Dr. Dave bought a stock 5 years ago for $100 and it grew to be worth $1,000 today. If Dr. Dave went to sell it, he would pay federal long-term capital gains on $900 (plus state income taxes). When Dr. Dave needs some cash for another investment, but doesn’t want to sell the stock and incur any taxes, he borrows $300 against the stock to make the new investment.

Die

Under our tax code, heirs get a “stepped-up basis” when they inherit an asset. An asset’s basis is the amount that was originally paid for that asset. Basis is not taxed.

Back to the case of Dr. Dave. Let’s assume he never sells his stock, holding it until his death, at which time it is worth $5,000. If Dave leaves the stock to his heirs, their cost basis is “stepped up” to $5,000, which is the value of the stock at the date of his death. Thus, the heirs could sell it the next day for $5,000, and pay nothing in taxes. In this way, capital gains taxes have been permanently avoided on the $4,900 gain or 98% of the value.

You may wonder about the loan of $300 that Dave took. In this case, Dave had flexibility while he was alive. Maybe the investment did well and he paid off the loan in full. Perhaps he kept paying interest and the $300 principal was still due. Perhaps the loan amortized and a balance remained. In these two cases, the heirs could sell just a small fraction of the $5,000 stock to pay off the loan and they would not pay any tax on the proceeds up to $5,000. In fact, if you multiply the value of the stock by 100, 1,000, 10,000 or more, the lender may be happy to rollover the loan to the heirs for years or decades. This happens every day.

Ways to use “buy, borrow, die” strategy

Let’s examine four ways physicians can use this strategy in their daily financial lives:

1. Second mortgages, HELOCs

The concept is simple. Rather than selling an asset to pay a large expense or make an investment, you borrow such funds from your home value through a second mortgage or home equity line of credit (HELOC). Physicians do this often when making a down payment for a second home, spending on large improvements on an existing home or paying a large tuition bill.

Once the funds are borrowed, like Dr. Dave, mentioned earlier, you have flexibility. You could pay down the loans, if that makes sense with your financial plan or you might finally pay the loans off when selling the home as part of retirement down-sizing. You could even keep those loans in place until death, or beyond, as your heirs may have the right, under federal law, to keep the loan running, if it is on a primary home.

2. Portfolio loans

In this option, the concept is the same as was just discussed, except an investment portfolio is used as collateral instead of a home, and no assets need to be sold taxably to access cash. In fact, this is often what billionaires do — take loans against their company stock. See the references that follow for information on Elon Musk and Fred Smith using this tactic.

In recent years, with interest rates being low, in general, and portfolio loan rates often being even lower than mortgage rates, portfolio loans have been extremely popular. As an example, Goldman Sachs recently was quoted as expecting its lending business on such loans to hit $10 billion, as the wealthy take out loans to cover taxes and all-cash real estate offers (see references). Certainly, it is not just the wealthy who have access to such loans, with lenders offering loans on portfolios with balances below $500,000.

Also, as with home loans, physicians will have flexibility in how quickly they pay off portfolio loans or whether they keep them until death. In speaking with one large portfolio lender, they said they work with an estate when the client has passed away and often end up renewing the loan with heirs, as long as the portfolio stays in place.

3. Cash value life insurance

In other articles and in our book Wealth Planning for the Modern Physician, we delve in more detail into the concept of permanent life insurance, also called cash value life insurance. Unlike term insurance, permanent policies have a “cash value,” which is a financial asset value that can be borrowed against using the same “buy, borrow, die” concepts as the first two techniques. For many reasons, however, cash value life insurance is the ideal tool for implementing this strategy.

First, the cash values within the life policy grow tax free. In this way, they are tax efficient in the accumulation phase in a way that portfolios may not enjoy.

Second, the loan rates on cash value loans can be contractually fixed when one purchases the policy initially. For example, suppose one such insurance policy has a contractually guaranteed 0.25% loan rate for the life of the policy. This means the policy owner will enjoy a near-zero loan rate to borrow against their cash values, whether they do so in 1 year, 10 years or 40 years. This is vastly superior to loan terms on HELOCs, second mortgages and portfolio loans.

Third, the death benefit of the life insurance policy is the very mechanism used to pay back the loan principal. In this way, the life product itself is designed to pay back the loan efficiently and the owner/borrower does not need to worry about other assets to pay it off. Let’s look at an example.

Example

Let’s revisit Dr. Dave. Let’s assume he has invested $20,000 per year into a cash value life policy and now has $300,000 of cash value and the policy death benefit is $1.5 million. If Dr. Dave needs $100,000, he can simply borrow it from the policy tax-free, choose to pay the contractually guaranteed interest from outside funds or from the policy cash values (meaning, nothing out of pocket). When he dies, if the $100,000 principal is still outstanding, the death benefit will be used to pay that loan balance off first and then remit to his beneficiaries. In this example, his heirs would simply get $1.4 million and the $100,000 would go to extinguish the loan. In this way, the tax-free loan for his current cash need and the efficient loan payoff were both accomplished within his cash value life policy.

4. Premium-financed cash value life insurance

The fourth way to use the “buy, borrow, die” strategy is the same as #3, but instead of paying the life insurance premiums with one’s own funds, in this case, one borrows the money to put into the policy. In fact, it may help to consider buying a home as analogous. One could pay taxes and save repeatedly over many years to buy a home for cash, as some people do. On the other hand, one could borrow the funds in order to buy the home, on which the lender then has a security interest, which is a mortgage.

The same concept applies with cash value life insurance. Some lenders loan money to people to invest in such a policy and the lenders also take a security interest in the policy until they are paid off. Of course, since one can make periodic investments in a policy by paying monthly, quarterly or annual premiums, many physicians never hear about or consider financing their premiums. This is much different than with real estate, where one typically needs the entire purchase price to buy the property.

Nonetheless, some savvy physicians have chosen to borrow the funds to invest in the cash value policy and thereby “supercharge” their potential benefit. However, like any complex strategy, especially one that uses leverage, the risks are higher, as well. Expert professional guidance is essential if one is considering this type of tactic, which really should be called “borrow, buy, borrow, die.”

References:

https://www.businessinsider.com/elon-musk-is-a-billionaire-who-doesnt-care-about-money-2020-5

https://www.businessinsider.com/securities-asset-backed-loans-no-taxes-real-estate-investing-sbloc-2021-11

Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting HEALIO to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.

www.peoplestaxpage.org/buy-borrow-die-1-1

www.wsj.com/articles/buy-borrow-die-how-rich-americans-live-off-their-paper-wealth-11625909583.

For more information:

Carole C. Foos, CPA, is a tax consultant and partner in the wealth management firm OJM Group www.ojmgroup.com. She can be reached at carole@ojmgroup.com or 877-656-4362.

David B. Mandell, JD, MBA, can be reached at mandell@ojmgroup.com.

Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon practicing at Northwestern Medicine in Warrenville, Illinois. He can be reached at sanjeevbhatia1@gmail.com or @DrBhatiaOrtho. David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy discussed herein.

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