If it feels like the rich play by a different set of rules, it’s because they do.
I recently learned about the concept of “Buy, Borrow, Die” and it’s fascinating. I’m not an expert on estate planning or taxes or am I rich enough to do this (yet!), but it highlights how different parts of tax law can come together to something (likely) unintended.
As far as I can tell, the origin of this framework (or at least the fun name) comes from Professor Edward McCaffery of the University of Southern California Gould School of Law. It’s outlined on his site People’s Tax Page on Tax Planning 101: Buy, Borrow, Die.
This strategy has three parts – buy, borrow, and die.
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Table of Contents
1. Buy
First, you buy something.
You have a big slug of money and you want to invest it in appreciating assets so you can retire forever. It’s also important that those appreciating assets do so tax-free (or more accurately, tax-deferred).
You’ll want to put this money into the stock market, real estate, or another asset class that appreciates. Buying a car would be a bad idea for this because the value of a car goes down over time. It’s also better if you pick an asset class that enjoys the tailwind of inflation pushing up its nominal value.
Real estate is almost perfect for this because:
- its value tends to go up,
- it is not volatile
- you can depreciate it, which reduces your income tax
- it’s easily accepted as collateral.
And the collateral is important for the second step. You want to pick an asset that can be used as collateral for a loan. Investing in your friend’s business is bad for this. Investing in your own business would be better, but not as good as real estate.
A bank may not want to use your business as collateral but they’ll all take real estate.
2. Borrow
Next, you borrow against your asset.
Typically, if you are asset rich and cash poor, you might sell some of your assets for cash to live. When you do, it triggers capital gains.
To avoid this, you don’t sell your assets to get cash. Instead, get a loan from the bank with your assets as collateral. By keeping the assets as they are, where they keep growing value, you don’t trigger a taxable event. You still get cash, it’s just a loan.
The best part about this is that when you get a loan, it’s not considered income. Since you’re borrowing against an asset, you’ve received cash in hand but you are also holding a loan that you must repay.
Use some of the proceeds of the loan to make the loan payments.
This is NOT a 401(k) Loan
If this sounds a little like taking a loan from your 401(k), it’s not the same. When you take a loan from your 401(k), you’re reducing the value of the account by the amount of the loan. You pay interest to yourself, which is kind of nice, but you miss out on any gains (or losses) that occur when the money is out of your 401(k).
We avoid any capital gains taxes because of the 401(k)’s tax-deferred status.
With the Buy Borrow Die strategy, your assets are used as collateral and never touched. It can continue to appreciate.
You get your cake and eat it too! (though you have to carve off a little slice to the bank as interest – so there’s no free lunch)
3. Die
Every good plan requires a good exit strategy and this one relies on the ultimate exit strategy – death.
You die.
When you die, your estate goes to your heirs. The loans are paid off with the assets and then the assets get a step-up in (cost) basis when they pass to your heirs. When your beneficiaries get those assets, their current cost basis in that asset is the current market price (at the time of your death). That step-up can save your heirs a ton in taxes.
For example, if I bought shares of Apple for $15 in 2011 and I died today (with it priced at ~$172), my beneficiaries get the step-up in cost basis. If they sell those shares today at $172 each, they will pay no capital gains tax because they had no gains. (They may have to pay estate taxes as a result of getting those shares.)
The strategy works because of the step up in cost basis of the asset. I paid $15 per share and if I sold it, I’d owe taxes on the gains. Because they got the shares after I died, they “paid” the higher price and if they sold it that day, they owe $0 because they had no gains.
What about the loan? You pay it off with the proceeds of the sale. Easy peasy.
Is There A Catch?
No catch.
Well, the catch is that your assets have to keep appreciating. And you have to die.
But we all do that so you might as well take advantage of it! (also, that part is in the name so if that comes as a surprise then good luck)
The advantage of this strategy is that when you borrow money from the bank instead of selling an asset for the cash, you pay the bank some interest and the government doesn’t get its capital gains tax. You have to go through a few more hoops because of the loan but it’s not hard to borrow against your stock portfolio. Selling an asset and reporting the sale on your tax return is easy and requires no application – but you pay taxes.
The other consideration is that it might not be the most efficient way of acquiring an asset in the first place. You can typically own real estate by paying a fraction of the cost of buying it. You can get a piece of property for a 20% down payment (sometimes less).
While there is no catch, there are two realities that make this strategy effective:
Low Interest Rates
Since you are borrowing against your assets, you need interest rates on that loan to be relatively low or you’re just paying interest instead of taxes. If you’re reading this in 2022, we’ve experienced some of the lowest interest rates we’ve ever seen in the last decade or so.
If they creep up, it makes this strategy less and less effective. The loans are almost always variable rate loans so if that rate goes up, your costs go up and this is not as appealing as it once was.
Stepped Up Basis
This strategy works so well because of the stepped-up in basis “loophole.” If that didn’t exist, this plan isn’t as effective (but is still helpful from a tax planning perspective). The step-up in basis removes a potentially huge chunk of gains from taxes.
If the step-up in basis were removed, you still benefit a little bit because you still get cash while retaining the asset so it can appreciate. You just have to keep paying the loan’s interest rate in the meantime so you need the asset to appreciate more than the interest rate on the loan. It’s really no different than borrowing money to invest, which is not unheard of, but you’re doing it in a way that avoids capital gains.
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This Isn’t That Crazy of an Idea
If the strategy sounds like a really crazy idea, it isn’t – we actually do this already with our homes.
You buy a home, which is generally an appreciating asset, and you can get a loan against the value of the home (home equity loan). When you go to sell, you can ignore $250,000 of gains as long as it was your primary residence (similar to step-up in basis). If the loan is still outstanding when you sell, you can pay back the home equity loan with the proceeds and it doesn’t impact the cost basis on your home.
Ever refinance the loan on your home after it’s appreciated? Cash out refi? It’s basically this same strategy.
The only thing missing is that you can’t depreciate the value of your home and use it to offset your income. 🙂
There are over $263 billion revolving home equity loans according to The Federal Reserve (data is from July 9th, 2021):
Home equity loans are simply loans taken out against the equity in your home. Buy Borrow Die is just a riff off this very popular idea.
The only wrinkle is that most people don’t take home equity loans for everyday spending money – they typically do it for major purchases but money is fungible. It doesn’t matter what you use it for.
Want to do this with your stock portfolio? Some, but not all, brokerages offer this. For example, Schwab calls it a Pledged Asset Line.
Now you know the Buy Borrow Die Strategy!
Go impress your friends at the country club. 🙂
Bob Smith says
So you borrowed say 300,000 of gains in 2021. And you spent it. Now it is 2022 and you have to pay principal and interest on it. Where does that money come from?
Then in 2022 you borrow another 300k . And you spend it. Now you are paying principal in an interest on 600K.
Seems like you are soon going to be having all money to debt service.
I believe the idea is that you don’t spend it all – you borrow $300,000 but you spend it over time and not all at once. The $300,000 can pay for the debt service while you are using it. Plus during all this time, your assets (hopefully) appreciate and you can “double dip” (spend some while the balance still grows).
Rahul says
May not be as simple as it sounds. For example, the interest on the loan that you borrow is paid “each” year. So let’s say that even if you borrow $100k at 3% instead of paying 15% capital gains, and you keep rolling over the loan, soon (within 5 years) you will have paid 15% on your original amount. In this situation, you would have been better off paying 15% capital gains in the first place.
Paying 3% a year for five years is better than paying 15% in year one – also because your investments are still invested in the market for those extra five years.
robert quintal says
I am curious about your thoughts on a reverse mortgage. A LOC version of a jumbo seems to fit your strategy nicely.
I think a reverse mortgage seems like it offers too many bells and whistles (and costs and requirements), which make it a slightly less appealing option. For example, if you were to use a home equity conversion mortgage (HECM), there are requirements that you are over 62 years old, have it be your principal residence, mostly paid off (or completely), etc. In return, you get a line of credit that you don’t have to make regular payments on but you also have to pay an upfront insurance premium (usually 2% of your house’s value) and origination fees, etc.
Richard Schlosberg says
Hey Jim, I have this nagging question about this strategy, I haven’t found an answer yet…. If I take a 300k loan out against 300k in invested assets to avoid taking any taxable cash out, how do I repay the loan without selling assets (or earning a salary) that will be taxed? Am I missing something here? you can just borrow 300k and then sell 325k in assets to pay the loan back…. you’d have to pay taxes on the 325k you liquidated right?
You pay it back with the money you received from the loan. In your case, you pay taxes on the gains on the assets.
Let’s say you have $300,000 in assets and you borrow $100,000 against those assets. You keep paying interest on the $100,000 loan but you can use the loan proceeds, the $100,000, to pay that interest.
At some point, you may want to sell your $300,000 in assets. When you do, you owe taxes only on the gains. If you purchased those assets for $300,000 then your gain is zero. You owe nothing in taxes.
If you bought them for $250,000 then you owe $50,000 in gains which are taxed based on your holding period and your tax bracket.
The loan has nothing to do with the taxes you pay on the sale of the assets.
Frank Z says
With all the recent discussions of billionaires tax, I still do not understand this concept fully. Say Elon Mask borrowed 500 millions for his mansions and yachts against his billions in TSLA stock. He eventually has to pay back the loans. He has to sell his stock to get the cash. Then he pays his 20% capital gain tax. So it’s not he avoids tax, it’s just he delays paying tax to the current administration. Even if he dies tomorrow and his heirs get a stepped up basis, the heirs pays no capital gain tax but still has to pay HUGE estate tax over the threshold (assuming current law of keeping the step up basis and the threshold of 22 millions for he and his wife). So the tax is just deferred but not avoided. All the talks is really politicians want your money and want it NOW. Am I correct in understanding this but borrow and die?
The piece you’re missing your explanation is that he doesn’t have to pay back the loans all at once. He pays back bit by bit, like other loans, and can always continue to borrow because he’s not borrowing shares, he’s borrowing dollars using his shares as collateral. So he is avoiding the capital gains tax because he’s getting cash and never selling shares.
The stepped up basis will reduce the burden on his heirs further but eventually estate taxes will take a chunk.
As for politicians, they care about votes and public opinion and it looks bad when ordinary Americans were struggling in 2020, couldn’t pay rent, needed stimulus checks, etc – while billionaires made billions. They want to appears to be doing something about this unfairness though I suspect there’s little chance this type of thing goes through.
Bruce says
Thanks for this advice, Jim. I have been mulling how it will work in my situation. I don’t earn much in annual income, but I have a fair amount in retirement and home equity. I have about $250K in equity, in a neighborhood that appreciates steadily (the house is currently valued at $700K). I plan to be in this house at least 5 more years. I will inherit another house in 10-15 years, and that will end up being my primary residence. I’m wondering if should apply this strategy now in some way, using my current equity as collateral. Or if I should just wait to cash out the equity I build up in the next decade, before moving into the inherited house.
You’re in a situation where this strategy doesn’t necessarily have a huge benefit to you because you can’t borrow against retirement assets and you already get tax benefits if you were to sell your home, though it sounds like you don’t want to do that for 10-15 years.
If you wanted to use this strategy, you could get a home equity loan against your home and use that as your spending money and the cost would be interest on that loan. When you sell your current home, you’ll get the tax benefits of selling a primary residence (no capital gains on the first $250,000 in gains, or $500k if you are married) and can use the proceeds to pay off the loan.
You are essentially cashing out the equity using this strategy, so it’s really the same thing. 🙂
Frank Z says
How do you comment on Elon Musk’s recent selling of near 10% of his stocks with billions in tax? One thing you did not mention in the strategy of borrowing and die is if the underlying business lost its value (AOL or Yahoo comes to mind), then it’s better for its founder to cash out while it was worth a lot?
I don’t understand what comment needs to be made about Elon Musk selling stock? He sold it, owes tax, end of story?
If the underlying asset loses value then the bank might need you to provide more collateral. Or pay down the loan so the ratio is within their ranges.
It’s not an “always win” scenario, just one that is useful if you have a large capital gain and you don’t want to realize it yet.
michael obossa says
Jim, since you’ve been so good about answering people’s questions here, please help me out with a relatively simple one, at least i hope so.
all of my googling like, “best banks for SBLOC” doesn’t lead me to anywhere with any sort of list or comparison of lenders, but instead, sites and articles like this one, which just talk about what it is and a little bit about the how, but no recommendations or lists of banks on where to get started.
i saw one youtube video where the woman said there are ONLY 4 banks which do these types of loans, is that true?
anyway, it would be very helpful to me and any other future readers here if you know which banks those are, or any recommendations.
thanks,
mike
Hi Mike – I’m not sure if there are only 4 backs that offer this but it’s not something that’s extremely common. What you’ll want is to use a broker that offers this, since they will be holding the assets, and they usually refer to them as Pledged Asset Lines (PAL) rather than SBLOC (this was the first time I heard that acronym). It sounds like they’re similar products though. Charles Schwab and Interactive Brokers are the two bigger brokers that offers this, I’d start there in your research.
db says
I think many of the comments are missing the point here. Buy, Borrow, Die.
With a “large” stock portfolio, rather than selling and paying taxes and losing future appreciation, you borrow.
Small detail – interest rate for borrowing against a “large” stock portfolio is much lower than a mortgage. Some say less than 2%, others say less than 1%. It depends on who you are and who your banking relationship is with. The larger the portfolio the less the rate.
The lower rate is a big benefit of this strategy. Is the interest on the loan tax deductible?
My main question is about the Die portion. The 30,000 foot view is that the step up basis happens and then the appreciated shares are sold at the stepped up basis, without cap gains taxes, to pay back the loan.
Is this actually true? The estate has to be settled before shares are passed to heirs (no?) and (it appears) the step up happens after the estate is settled. This is the key to the strategy working. When does the step up happen and when is the load paid back? If the loan is paid within the estate process and the shares aren’t yet stepped up, there’s a cap gain payment due.