Realized capital gains are subject to favorable tax treatment, but what if you could avoid ever paying any taxes on your capital gains? The “buy, borrow, die” strategy seeks to do just that.
To employ this strategy you buy appreciating assets, take out loans against your equity in those assets, and then your heirs receive a step-up in basis when you pass away. Because you didn’t realize the capital gains during your lifetime, the capital gains are never taxed.
The Basics of Buy, Borrow, Die
Buy
The first step in this process is purchasing assets that will appreciate. Common assets used for this process are stocks or real estate. You’ll want to look for assets that will have long-term appreciation.
When purchasing stocks, you’ll want to purchase the stocks in a margin account. Margin accounts allow you to take loans against your stocks. The margin can either be taken out of the account as cash or used to purchase additional assets.
The real estate involved in this strategy can be your primary residence but is more often an investment property. Either residential real estate or commercial real estate is appropriate. When considering which real estate assets to purchase, you’ll want to look for real estate with high anticipated future appreciation.
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Borrow
While you could sell an appreciated asset and realize the capital gain, borrowing against the value of your assets allows you to tap the equity while still holding on to your asset.
This works the same way as a home equity line of credit (HELOC). A HELOC allows you to access the equity in your home without having to sell the home. While HELOCs are often used to finance upgrades to your home, you can use the funds for any purpose.
Taking on margin against your brokerage account will allow you to access the equity in your account without having to sell the stocks. Marginning stocks is not without risks which we’ll look at later.
Your brokerage will determine the required equity in the account and will vary based on the stocks held, the overall size of the account, and the assessed risk level. The rules vary significantly by brokerage, but you can usually borrow approximately 30% of the value of your stocks. Some brokerages will allow you to go up to 60% of the value.
Real estate affords you greater opportunities for borrowing. Mortgage lenders typically require 20-25% equity left in your home on a cash-out refinance. Consider a homeowner who purchased their home 15 years ago for $500,000 and have paid off their property. If the home is worth $2,000,000 today, the homeowners could assess up to $1,500,000 ($2,000,000 * 75%) through a cash-out refinance or establishing a HELOC. Thus, they are accessing the equity without realizing any capital gains.
Note that the borrowing stage becomes much more expensive in a high-interest rate environment, although borrowers with significant assets and good credit scores will qualify for favorable interest rates. The buy, borrow, die strategy only makes sense when you can earn a higher rate of return on the asset than the interest you are paying. Clearly, this strategy was more advantageous when interest rates spent a decade near record lows before the recent and dramatic rise in rates offered by lenders.
Die
Though you won’t benefit at this point in the strategy, your heirs will.
When you pass your assets on to your heirs, they receive a stepped-up basis in the property. So if you purchased the home above for $500,000, and it’s worth $2,000,000 when you die, your heirs’ basis in the property is $2,000,000. If they immediately sell the property for $2,000,000, then they will not realize any capital gains on the sale.
At this point, you have benefited from being able to borrow against the appreciated asset, never having to pay the capital gains on the appreciation (since you never created a realized gain by selling the asset), and your heirs receive the property at an increased basis.
Benefits of the Buy, Borrow, Die Strategy
Aviod Capital Gains Tax:
As noted above, one of the biggest benefits of the buy, borrow, die strategy is the opportunity to avoid capital gains taxes by not realizing capital gains during your lifetime.
Effective Leveraging
Buy, borrow, die also allows you to effectively leverage your appreciated assets giving you liquidity during your lifetime, even if you own illiquid assets. As long as you can borrow at a rate that is less than your return on the asset. For example, if you own a real estate asset that appreciates at 8% a year, but you can take a loan against an asset for 5% a year, you are coming out ahead by taking the loan instead of selling the asset.
Estate Planning
When you pass away, if your estate is higher than the lifetime exemption amount, you will pay estate taxes on your net assets. As of 2023, the lifetime exemption is $12.92 million per person. So if you employ the buy, borrow, die strategy, any loans you have taken against your assets will be deducted from the total value of your estate.
Flexibility
This strategy also gives you the flexibility to borrow against your assets. For certain assets, such as real estate, you can preemptively establish lines of credit that allow you access to funds whenever you need them. Margin against stocks works similarly in that you can access the funds at any time.
Potential Tax Deductions
Depending on what type of borrowing and how the funds are ultimately used, you may be able to deduct the interest expense on loans you take out. Note that the IRS has very specific rules on what interest is deductible. Investment interest is deductible up to your investment income. HELOC interest is deductible for any purpose on up to $100,000 of debt, but if the debt is greater than that amount, the funds need to be used for home improvements.
You may also use the interest tracing rules for deducting interest. Under the interest tracing rules, the interest expense is deductible based on how the funds are used. For example, if you take $300,000 against margin and use the funds to purchase a rental property, the margin interest would be deductible as other interest on your Schedule E.
Risks of the Buy, Borrow, Die Strategy
The buy, borrow, die strategy is not without risks.
Assets Decreasing in Value
Though you may plan on continued appreciation of your assets, you may find yourself with assets that stagnate or depreciate over time. In this case, you may end of in a situation where you can no longer borrow against your assets or that your loans are at a higher rate than your return on your assets. In these cases, you may need to sell the asset to get access to cash and have to pay off any existing loans when you sell. This will leave you with little cash to take out of the property.
Margin Calls
Margin can be especially tricky to use unless you have a very substantial portfolio. Even short-term drops in asset values (think: the flash crash of 2010) can trigger margin calls. A margin call requires you to put in additional cash to pay off the margin or to sell some of your assets to pay off the margin until you are back within your brokerage account’s margin requirements.
Any time you take on debt, it should be done carefully with a long-term plan in mind. If you have a large portfolio that allows significant margin or a large HELOC, it can be tempting to use it without carefully monitoring your expenses.
Estate Liquidity
Your heirs may need to pay off your loans and lines of credit upon your death (or they may be subject to estate taxes). In each of these situations, your heirs may need to access cash which will require them to sell assets that they may otherwise want to hold onto.
Interest Rate Fluctuations
Most of the borrowing under the buy, borrow, die strategy is subject to interest rate fluctuations. Margin and lines of credit are usually tied to market interest rates. In today’s high-interest-rate environment, it may be difficult to find loans that have interest rates lower than the appreciation of your assets.
The buy, borrow, die strategy has been available to wealthy individuals under current tax laws, but that doesn’t mean that future changes to tax laws will allow this strategy to continue. You should have a backup plan in mind for accessing cash in the future if future laws clamp down on your ability to borrow against assets or change the deductibility of certain types of interest. It’s also possible that the stepped-up basis on death could be ended via legislation, a change which would erase the capital gains savings.
Compared with Other Wealth Strategies
There are other wealth planning strategies that may be more appropriate for your financial situation and long-term plans.
Selling Assets and Paying Capital Gains Taxes
This strategy gives you immediate liquidity and the funds can be used however you wish. You can also time the realization of capital gains to benefit from lower tax rates in certain years when your income is lower. You also have the benefit of knowing the current tax rates and tax bill that comes with the sale (unlike holding on to assets and hoping there is beneficial treatment when you die).
The downside is that you will have to pay capital gains taxes (unless you are in the 0% capital gains tax bracket) which will lower the funds you have to spend or reinvest. You’ll also be giving up any future appreciation of the asset (although you will also avoid any future depreciation).
Gifting During Your Lifetime
This is the simplest strategy for passing funds to your heirs. You simply make gifts during your lifetime of either cash or assets. In 2023, you can give any person a gift of $17,000 tax-free and without using up your lifetime estate tax exemption. Married couples can give up to $34,000 each year to any individual. A couple could give another couple $68,000 each year. This way, you get to see the benefit of your gifts while you’re alive and can work within the current tax laws. Any gift would reduce the size of your estate.
The downside of this strategy is that you lose control of the assets once they are given away. You will also no longer benefit from any future appreciation of the gifts. Any gift given during your lifetime will also not receive a stepped-up basis upon your death. In fact, a gift given during your lifetime has a basis of the lower of your adjusted basis or the fair market value at the time of the gift.
Establishing Trusts
Trusts, when made correctly, can minimize the estate and gift taxes while protecting your assets for your heirs. You will also retain control over how the assets are used during your lifetime, and how the income is distributed during your lifetime. Trusts have the additional benefit of being protected from creditors and legal judgments against you.
The downside of trusts is that the setup and running of trust requires well-written legal documentation and ongoing financial management. Depending on the type of trust, you’ll need to file a separate trust tax return each year. In some cases, such as irrevocable trusts, you give up all rights to the assets (techically, at least).
Any combination of the above strategies along with the buy, borrow, die might be appropriate for you given your own unique financial situation and long-term goals.
Criticism of the Strategy
The buy, borrow, die strategy is legal under current tax law, but it’s not without its critics. Some argue that the strategy amounts to exploitation of what they consider a loophole in the tax law that allows wealthy taxpayers to avoid paying capital gains taxes.
Others are calling for legislative changes that would change the tax implications of the buy, borrow, die strategy, so if you are considering this strategy, you’ll want to have a backup plan in place in case the laws change in the future, although the laws are rarely enacted retroactively.
Final Thoughts
The buy, borrow, die strategy can be effective because of its tax efficiency and ability to retain control over your assets. It’s not without risks, such as rising interest rates, overleveraging, and future changes in tax laws. You should consider your overall financial picture, other options, and long-term goals before employing this strategy.
