How the Rich Avoid Taxes (The Buy, Borrow, Die Strategy)

➡️ How the rich avoid taxes

Investing your money is a smart path to wealth, but taxes can dig deep into your earnings. To shield your wealth from heavy taxes, you can follow the “buy, borrow, die” strategy. This approach, coined by Professor Ed McCaffery in the 1990s, reveals how the rich avoid taxes.

It’s worth noting that nearly three decades later, this term has regained prominence in conversations about tax fairness and methods for everyday people to lighten their tax load, a topic we’ll explore shortly.

If you’re seeking guidance on your investment journey, ponder teaming up with a financial advisor.

Don’t Do ThisWhat to Do Instead
Buy Depreciating AssetsBuy Appreciating Assets (e.g., stocks, real estate)
Use Cash to Make PurchasesBorrow Against Assets as Collateral for Loans
Sell Investments for CashLeverage Assets to Avoid Capital Gains Tax
Neglect Estate PlanningPlan for Estate Transfer to Minimize Taxes
Ignore Tax-Efficient InvestingConsider Tax-Efficient Investments
Neglect Emergency FundsMaintain Adequate Emergency Funds for Financial Security
Rely Solely on a Single IncomeDiversify Income Sources and Investments

➡️ What is the Buy, Borrow, Die strategy?

“Buy, borrow, die” is a concept that sheds light on how affluent individuals manage to preserve their wealth by reducing their tax obligations.

This theory asserts that wealthy people aren’t exploiting tax loopholes or engaging in deceptive tactics. Instead, they’re minimizing their tax burdens through astute investment strategies and thoughtful planning.

The term comprises these three integral components, which elucidate the strategy’s mechanics. Professor McCaffery introduced this concept to illustrate how wealthy individuals structure their finances to proportionally pay less in taxes than the typical American.

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➡️ How does the Buy, Borrow, Die Strategy work?

The buy, borrow, die strategy is surprisingly simple to grasp once you delve into the meaning of each of its three components.

Let’s break down each step individually to gain a clearer understanding of the process.

Step 1: Buy

In this first step, you do exactly what it sounds like: you use a portion of your wealth to acquire assets that tend to increase in value. These assets can be things such as:

The purpose behind this is to benefit from the rise in value that these assets typically experience over time.

For instance, real estate often becomes more valuable year after year, unlike vehicles and certain other types of property.

Owning real estate can also act as a safeguard against rising inflation or market instability.

Furthermore, purchasing real estate can come with tax advantages, particularly if you can claim depreciation deductions.

If you own a rental property that you lease out either seasonally or year-round, you can also generate a regular income.

Ideally, you want to invest in assets that will increase in value on a tax-deferred basis and provide you with passive income.

Passive income is money you earn without actively working for it. For instance, dividends from stocks are a form of passive income.

Part 2: Borrow

Once you’ve acquired these appreciating assets, the next step involves borrowing against them. In simpler terms, you use these assets as collateral to secure loans.

Why would you do this? Well, according to the “buy, borrow, die” strategy, using your assets as collateral allows you to borrow money while safeguarding the value of these assets.

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This is an advantageous move because it means you don’t have to sell your investments to obtain cash, thereby avoiding capital gains taxes. Additionally, the loan proceeds don’t count as taxable income.

However, it’s essential to choose the right assets as loan collateral. This is where owning real estate can be beneficial since you can use it as collateral to obtain loans.

On the other hand, borrowing from your retirement account can deplete your wealth and potentially lead to tax implications.

For instance, if you borrow from a 401(k) account, you’re essentially borrowing from yourself. However, any money you withdraw doesn’t continue to grow on a tax-deferred basis.

This can hinder your long-term wealth-building strategy. There’s also a risk involved, as failure to repay the loan could result in the IRS treating the entire amount as taxable income.

Part 3: Die

Contemplating mortality isn’t pleasant, but wealthier individuals grasp the importance of estate planning and what occurs with their assets when they pass away.

Often, a top priority is minimizing estate taxes, as doing so allows you to leave a larger portion of your wealth to your loved ones.

In the “buy, borrow, die” strategy, those who inherit your estate can use some of the assets you’ve bequeathed to settle any outstanding loans. This spares them from having to cover these debts from their own funds.

Furthermore, your heirs benefit from an adjustment in the cost basis of these assets once they receive them. This adjustment enables them to avoid paying capital gains tax when they eventually sell the inherited assets.

Alternatively, they can choose to retain the assets and continue implementing the “buy, borrow, die” strategy for themselves and future generations.

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➡️ Does the Buy, Borrow, Die strategy really work?

The buy, borrow, die strategy can indeed be an effective way to reduce your tax burden, but it’s most suitable for those who have the financial means to implement it.

Here’s how it generally works:

Investing in assets that tend to increase in value over time allows you to benefit from their long-term growth while potentially generating some current income. These assets can then be used as collateral for loans, and the loan proceeds aren’t considered taxable income.

However, there’s a significant caveat with this strategy. It necessitates a certain level of wealth to get started. Individuals with a net worth in the four- or five-figure range, for instance, might find it challenging to acquire appreciating assets.

This may not be a concern for someone whose net worth exceeds $1 million.

In essence, it takes money to make money through the buy, borrow, die strategy, which may not be feasible for many people. If you already own a home, you might possess an appreciating asset to begin with.

Nevertheless, your borrowing options against your home could be limited to a home equity loan or a line of credit.

Opting for a home equity loan or a HELOC to access funds can pose risks if you struggle to keep up with the payments.

Defaulting on the loan might prompt the lender to initiate foreclosure proceedings, potentially leading to the loss of your valuable asset in the worst-case scenario.

➡️ Final thoughts

In conclusion, the buy, borrow, die strategy presents a legitimate approach to reducing your tax obligations while striving to build wealth.

However, it’s important to acknowledge that implementing this strategy can be challenging, particularly if you have limited financial resources.

In the meantime, there are more traditional methods you can employ to grow your wealth. For instance, you can maximize contributions to your 401(k) or consider opening an Individual Retirement Account (IRA), both of which offer tax advantages.

Additionally, it’s wise to explore estate planning, an essential aspect of your financial strategy. Beyond tax planning, you should consider how your assets will be passed on to your heirs.

Establishing a will is a fundamental step, but you might also want to explore the benefits of creating a trust. Other factors to take into account include assessing your life insurance needs and developing supplementary income streams.

An annuity, for instance, can provide a consistent source of retirement income, allowing you to preserve your other assets.

(Source: SmartAsset)

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Hey — It’s Pavlos. Just another human sharing my thoughts on all things money. Nothing more, nothing less.