The “Buy, Borrow, Die” Strategy was made famous by a ProPublica report that provided insight into the tax situation for many of America’s ultra wealthy. Earlier this year, ProPublica published an article discussing the strategy many billionaires use to avoid paying taxes. Even though these individuals are experiencing vast increases in their wealth year after year, they still manage to set up their investments in such a way that they pay little to no taxes.
The Buy, Borrow, Die strategy is not new to tax professionals. This approach, or variations of it, have been used for years to develop strategies for accumulating vast sums of wealth and passing that wealth down to heirs without paying a big chunk to the IRS. Many have the false belief that these billionaires are breaking the law. But the truth is, these strategies are blessed in the tax code and available to everyone.
What is the Buy, Borrow, Die Strategy?
1. Buy: Buy an asset or start a company
Example: Jeff Bezos starts Amazon and the value of his shares in Amazon increases over time.
When you own an asset, you are not required to pay any tax unless you receive income from the asset or sell the asset and recognize a gain. When Bezos started Amazon, the shares were virtually worthless. Over time, as Amazon grew, the value of those shares came to be worth billions of dollars. However, as long as Amazon does not pay a dividend to shareholders (tech companies rarely if ever pay material dividends) and Bezos does not sell any of his shares, he will not owe any tax on the value of those shares.
The strategy could really be renamed “Buy, Hold, Borrow, Die” because the key requirement for it to work is to hold the asset throughout your life without ever selling any shares and recognizing the gains for tax purposes.
2. Borrow: Take out loans against your assets to fund expenses
Example: Bezos gets a loan from a bank to fund his lifestyle costs and uses his shares of Amazon as collateral for the loan.
Taking out a loan with shares of stock as collateral on that loan is a way to have access to the value of the shares without having to pay any tax. As stated before, if you do not sell the asset, you will not pay any tax on the appreciation in the shares. You can use the cash from the loan to fund your living expenses over time. This can prevent you from having to sell any shares to fund your cost of living.
The loan proceeds are required to be paid back to the lender over time. Therefore, you do not owe any tax when you receive the cash from the loan. If structured properly, you may also receive a tax deduction for interest paid on the loan.
3. Die: Heirs receive a step-up in basis in the assets inherited
Example: Bezos’s heirs will receive a step-up in basis in the Amazon shares inherited upon his death.
Under current law, heirs receive what is called a “step-up” in basis in assets received from a decedent’s estate. Instead of having the same basis as the decedent, the heir is able to step-up their basis in the asset to the fair market value on the date of death. This means that when Bezos dies, his heirs will have a basis equal to the fair market value of Amazon’s shares on his date of death. If those shares are immediately sold, the heir should recognize no gain as the amount received for the shares (FMV) will be equal to their tax basis (also FMV).
There are also other strategies and estate planning techniques for passing down assets to future generations without incurring estate tax.
4. Repeat: Heirs liquidate appreciated asset and repeat the same cycle
After getting the benefit of a step-up in basis, heirs can sell the assets and receive the cash while paying no tax. This allows them to then repeat the same strategy by starting a new business or buying new shares of stock. The cycle can be repeated indefinitely allowing families to generate massive amounts of wealth and pass that wealth down to their heirs tax-free.
Notably, there has been some recent discussion about eliminating the benefit of the step-up in basis. However, to date, this has not received enough support from Congress and would likely face significant pushback from moderate Democrats and Conservatives.
The Catch → They Do Actually Pay Some Tax
Most of the billionaires covered in the report earned the bulk of their wealth by starting companies. Those companies were later taken public and are formed as C Corporations. C Corporations pay a corporate level tax on net income each year (at a current rate of 21%). The individual owner will not pay any personal taxes unless they receive a dividend from the company or sell their shares.
The often less-discussed result of this is that for any billionaires owning shares in a C Corporation, they are in effect paying tax by way of the reduction of their allocable share of value of the company for any corporate tax paid.
For example, any tax paid by Amazon is going to have an impact on the value of the company. This will have an indirect impact on the value of Jeff Bezos’s shares in Amazon. Therefore, even though Jeff Bezos may not pay personal income tax on the billions of dollars of net worth he has in Amazon shares, he is still technically impacted by the corporate tax paid by the company.
How Can I Use This Strategy?
One of the most common questions I get from clients is how they can use this same strategy. On its face, the Buy, Borrow, Die strategy really only works when you hold a substantial number of shares in a public company. The difference between Bezos and the average business owner is that banks are happy to lend to the founder of a public company where shares of that company are pledged as collateral on the loan. If Bezos is unable to repay the loan, the bank is content taking over the shares of Amazon.
However, a bank is less likely to want to lend to the average Joe where shares in Joe’s construction company are the collateral on the loan. The bank does not know Joe and will not be as happy finding themselves owning a large stake in a small construction company.
With that said, there are variations of the Buy, Borrow, Die strategy that can work for those of us who are not billionaires. These types of principles should be incorporated into any investment and business strategy to make sure you are not paying too much tax. You don’t have to be a billionaire to take advantage of these sophisticated tax planning strategies.