Unlocking Financial Freedom: The Buy, Borrow, Die Tax Strategy Explained

If you haven’t yet heard of the tax strategy “Buy, Borrow, Die,” you’re not alone. It was a popular term during the 1990s and then faded out of usage in many circles. Recently, the term has made a resurgence as more and more people look for ways to reduce their tax burdens and build additional financial security. While wealthy people commonly use this strategy, there are ways for those who aren’t rich to make it work as well.

It’s not as morbid as it might sound, and it’s a fully legal way to hang onto more of what you own and pass it down to future generations. That not only helps you reduce your tax burden and enjoy a better lifestyle, but it can help your heirs by giving them something they can use to start building their own wealth after you pass away. While this strategy can be extremely effective, one must execute it correctly and should be aware of the risks as well as the benefits. Here’s what you need to know.

What is the Buy Borrow Die Tax Strategy?

This strategy involves buying assets, typically investment properties or other real estate, using them to borrow money against, and holding onto them so that you can pass them down to the next generation. It’s a way for people who have wealth to avoid capital gains tax while their assets continue to appreciate, and while they use those assets as collateral for loans to fund their lifestyle, make purchases, or buy other investments.

Making wise investments is an extremely important part of this strategy, because the investments have to grow in value in order to continue building wealth. It’s very important to choose properties based on what the market is looking for, not what you personally like. These assets aren’t for you to live or work in, and are for the sole purpose of appreciating in value and borrowing against.

Additionally, you have to hold those investments properly. If you sell them outright, for example, you can have significant capital gains cost on their value. Understanding the value of this strategy and how to execute it correctly is an important way to build generational wealth that can work for you during your lifetime and also help your heirs have a starting point to continue building wealth and security.

Related: Why Doctors Should Consider Real Estate Investing

Where Did This Strategy Come From?

The strategy itself has been around for decades, but the term for it was coined by University of Southern California law professor Edward McCaffery in the 1990s. He was asked about building wealth and was quoted as saying, “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.”

It’s not technically necessary to be rich before employing this strategy, though. As you start to build up savings and increase your income you can start purchasing assets that will hopefully grow in value. As these assets grow you can then borrow against them. Over time that can make you rich, even if you don’t start out that way, and can also help future generations in your family continue to do the same thing.

Are There Other, Similar Methods?

The buy borrow die method is relatively unique, as there are only so many ways to leverage assets in order to make more money over time and avoid at least the majority of taxes. Some people look for write-offs they can use to reduce their tax burden, but this often doesn’t offset their income enough. Additionally, expenses such as term life insurance and other important protections are highly valuable but aren’t very beneficial for reducing tax.

However, one similar method is to avoid capital gains tax by selling investment properties and purchasing other investment properties with the proceeds. Called a 1031 Exchange, this defers capital gains until the purchased property is sold. That can be a very effective way of building additional wealth through appreciating properties, while still keeping tax bills low.

The 1031 Exchange differs significantly from the buy-borrow-die strategy because it specifies what you must sell, what you can buy, and sets a specific time frame for completing the transaction that begins with the sale of one property and concludes with the purchase of another. With buy borrow die you can simply leverage the value of the investment property any way you want. The purchase of another property or other asset isn’t necessary.

How Has the Buy Borrow Die Strategy Changed Over Time?

During the 1990s, when McCaffery was quoted regarding this strategy, it wasn’t as widely known. Many people who were building wealth or already had significant wealth accumulated used the strategy to their benefit. But talking about how it was done mostly faded out, with the exception of certain circles. With today’s concerns over tax inequality and other economic worries, the term has resurfaced as a way that people who aren’t rich can learn to build wealth and reduce tax burdens.

Read this: What Physicians Need to Know About Cash Balance Plans

How Does This Actually Work?

To better understand the buy borrow die strategy it’s important to get into the specifics of it a little more. As a start, you would purchase an asset such as real estate. The goal is to make that purchase in a way that maximizes the value you’re getting, and you also want to look for assets that will rise in value over time. Then, you would borrow from a bank or brokerage firm, using the asset you purchased as collateral for the loan.

Rates

The rates on these kinds of loans are generally less than rates for a standard mortgage, and most of the time there isn’t even a monthly payment. Using investments as collateral can lead to borrowing large amounts of money, and you can use that money to purchase more assets. Wealth accumulation begins to happen rapidly, and there’s no capital gains tax on the investment assets because you’re not selling them.

Tax Benefits

Not only are you getting tax benefits when it comes to capital gains tax, but the interest you’re paying on the loans against your investment properties is also tax-deductible. That provides you with more benefits, and can help offset some of your income for additional savings.

Passing it Along

When you pass away, your heirs receive your assets on a ‘stepped-up’ basis. This means that the assets will undergo an adjustment to their market value at the time of your death, for taxation and accounting purposes.. Your heirs will probably choose to sell those assets eventually. When they do, they’ll only pay capital gains on the appreciation that took place after your death, not on the additional appreciation that took place while you owned the assets.

Any estate that comes in below the estate tax threshold will also avoid estate taxes, once again reducing any tax burdens paid by you or your heirs. In short, you can purchase assets, take out loans against them to fund your lifestyle and additional investments, and then minimize the tax bill for your heirs who inherit the assets. But there are some risks to this strategy, and it’s also important to talk about how to handle those.

What are the Best Ways to Maximize The Strategy?

Maximizing the buy borrow die strategy is important, because you want to get everything you can from it. That gives you the best value and ensures you can reduce your capital gains tax and other tax burdens as much as possible. To maximize this strategy, start on it as early as you can. Also, make sure you’re choosing trusted partners for your borrowing needs. You want to have a good interest rate and low or no monthly payments required.

You’ll still need to pay back the loan, but being able to do that on your terms is easier. It’s also a good idea to make sure you’re following good estate planning guidelines to give your heirs as much protection as possible. Your will and other end-of-life documents should be in place, and you’ll want to consider a good life insurance policy, as well. Peace of mind is valuable, and you can get that peace with a few simple documents.

Related: 3 Ways to Avoid Taxes on Life Insurance Benefits

Are There Big Pros and Cons?

The biggest pros to the buy borrow die strategy are the tax advantages. Avoiding capital gains tax, and helping protect your heirs from having to pay that tax are both significant. Additionally, you can reduce your overall tax burden and fund an enjoyable lifestyle as you increase your wealth for a better quality of life. But like any decision, there are always downsides and risks.

The largest concern when it comes to this strategy is the value of the assets you hold. Making wise investments matters, and if your assets decline in value you could end up with more owed on those assets than they’re actually worth. That can stop you from continuing to borrow against the assets, making it hard for you to keep your current lifestyle or continue investing in other assets for the future.

In a worst-case scenario you may need to sell some of your assets to pay off loans or otherwise address financial issues. But that comes with the added problem of then having to pay capital gains tax on the increase in value (if any) of those assets. Making smart decisions about the properties or other assets you purchase matters, because you’re putting your financial future into those assets, as well as the future of your heirs.

Another downside to this strategy is that your heirs will be responsible for paying any loans you’ve taken against your assets if you don’t pay those loans in full before you pass away. If you’re trying to leave a financial legacy for your heirs, you don’t want them to end up paying back a lot of money that you own. Instead, you want to have a plan to pay off your loans as efficiently as possible, with the goal of not owing money in your later years.

What Else Should You Know About The Strategy?

The buy borrow die strategy is completely legal, and wealthy people have been using this tax reduction method for decades. There’s no reason you can’t use it, as well. Buying assets to get started is often the largest hurdle most people face. Once the first asset has been purchased, though, borrowing against it and continuing to grow your wealth and reduce your taxes is the goal. The more assets you own the easier this becomes to continue.

Holding onto your wealth through the buy borrow die strategy not only benefits you, but can also help your heirs have a solid base to start from with their own wealth-building goals. You’ll be setting them up for financial success, along with enjoying the benefits of this tax planning strategy in your own lifetime. With so much to offer, this is one of the most popular strategies for reducing tax burdens.Make sure you also understand the risks before you get started.

Related: The Beginner’s Guide to Physician Tax Planning

The Right Tax Planning Support Can Make All the Difference

Getting proper support for tax planning is a great way to feel confident that you’re making smart financial choices. Physicians Thrive provides full-fledged tax planning services, and we would love to talk to you about the buy borrow die method and other tax reduction options. Schedule a free initial consultation today, to get started.

In addition to tax planning, Physicians Thrive also has a real estate partner we can recommend. No matter where in the US you’re located, you can get help for buying or selling. When you’re ready to start purchasing assets and reducing your tax burden to build wealth, we’re here for your needs.

Related Reading: Trust vs Will: Making Informed Choices for Your Estate Planning

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