One of the stark differences between the rich and the poor is the way they view debt.
For the former, debt is a footstool to climb up the wealth ladder. For the latter, debt is a weight that can weigh their finances down and keep them in perpetual poverty. One way the rich use debt to enrich themselves is the Buy, borrow, die strategy.
You may be thinking: How come they borrow money when they have a lot?
The answer to that question is Buy, Borrow and Die.
This is a fascinating technique that the wealthy use to control their wealth and pass it down to future generations.
The wealthy have also become masters at buying, borrowing, and dying while paying minimal taxes or no taxes at all.
A report published on ProPublica showed that the 25 richest Americans (by Forbes’ ranking) paid a “true tax rate” of just 3.4% on wealth growth of $401 billion between 2014 and 2018.
Jeff Bezos — one-time richest man in the world — paid a true tax rate of 0.98% of his wealth from 2016 to 2018. Tesla founder Elon Musk paid 3.27% of his wealth as federal income taxes within that period.
Billionaire investor Warren Buffett, who saw his wealth grow by more than $24 billion within the same period paid a true tax rate of 0.10%
Some may scoff at the tax system saying that it only favors the rich, but the reality is far from that. Fortunately, this technique applies to anyone willing to learn and put it to use. You do not need to be rich to make a profit from knowing this information.
Let's look at how you can use buy, borrow and die to protect you and transfer your wealth with minimal tax costs.
First, you buy an asset that you can borrow against.
This could be an asset that appreciates but the two most popular assets are stocks and real estate, with the latter being the more preferred by lenders. This is because real estate prices tend to go up in the long term, and are less volatile than stocks. You can also depreciate real estate and reduce your income tax.
Next, you borrow against your asset.
The common logic is selling your assets to raise money if you are asset rich and cash poor. But when you do, it triggers capital gains that are taxed.
To avoid this, you don’t sell your assets to get cash. Rather you collateralize your asset, this implies using your assets as collateral to obtain loans. Since loans are not considered income, they are not taxable. But you do have to pay interest to the bank.
If you have stocks as assets, you can borrow against your securities through SBLOCs. This is an easy and inexpensive way to access extra cash by borrowing against the assets in your investment portfolio without having to liquidate these securities.
However, in most cases, real estate is used and seems to be the preferred choice for the wealthy.
Every good plan needs a decent exit strategy, and this one depends on the best one of all: death.
Your estate belongs to your heirs once you pass away. The assets are used to pay off the debts, and when the assets are passed on to your heirs, their (cost) basis is increased.
Your beneficiaries' current cost basis in those assets when they inherit them is equal to the asset's current market value (at the time of your death). Your heirs might pay much less in taxes thanks to that step-up.
For example, if I bought shares of Apple for $145 and it appreciates 4 times higher than at the time when I passed on ($580), my beneficiaries get the step-up in cost basis.
If they sell those shares today at $580 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 $145 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. The loan can also be paid off with the proceeds of the sale.
This strategy is an effective way of ensuring your dependents are well taken care of after you have passed on.
Because your assets are collateralized and never touched, they continue to appreciate value (see why real estate is the preferred choice for the wealthy?).
A hidden benefit is that your asset's appreciation can offset the interest rates paid on the loan. As your asset increases in value, its increment may surpass accumulated interest paid on the loan, which technically is a profit for you.
Debt is not taxed. When people borrow against vast amounts of valuable assets, they don’t pay tax, because the tax code does not count debt as income.
When you borrow money from the bank instead of selling an asset for cash, you pay the bank some interest and the government doesn’t get its capital gains tax. This is unlike taking a loan from your 401(k) whereby the value of your contribution is reduced.
You can compound using this strategy.
The loan obtained against your asset can be used to acquire another investment with cash flow that you can borrow against again. This cycle of borrowing and investing in assets that generate cash flow stacks up assets for you and increases your net worth over time.
This strategy works more efficiently if your asset is real estate. Unlike stocks where you may have to pay for the full price, you can lock real estate with down payment.
One demerit of this strategy as a way to accumulate wealth 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. A 20% down payment (sometimes less) can get you a piece of property.
You also need a huge amount of money to benefit from this strategy. It may take time to build your assets and portfolio to a level where you can benefit from this strategy.
Since you are borrowing against your assets, interest rates would affect the total cost of your loan.
As such, you need interest rates on that loan to be relatively low. If interest rates creep up, it makes this strategy less effective and unprofitable. Your best bet is using a fixed-rate loan as this accommodates periods when the interest rate would be higher, and also allows you to plan your repayments.
A variable rate loan may not be appealing, since it would be adjusted according to benchmark rates set by the Fed.
Although it appears that the wealthy are the only ones who may benefit from many of these tax avoidance techniques, practically everyone with assets can do so.
Even if you aren't a billionaire yet, you may probably benefit from simple tax planning techniques like making contributions to tax-advantaged accounts (like IRAs and 401ks), taking out loans against taxable assets (such as stocks and real estate), and making sure your estate is properly planned.
You can purchase, borrow, and pass away without paying taxes if you put these fundamental tactics in place.
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