“Buy, Borrow, Die” Estate Planning Strategy Explained

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.

If you need to create an estate plan, consider Trust & Will. They can help you set up an estate plan that’s a fraction of the cost of hiring a lawyer to help you draw up a will. It’s certainly worth a look if you haven’t set this up already.

There are also several free online will makers you can use instead.

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. 🙂