Turning Debt into an Asset
Exploring the Buy, Borrow, Die Strategy Amidst Rising Interest Rates
As a credit management company partnering with financing advisors, Sora Finance is sometimes asked about the Buy, Borrow, Die strategy of wealth accumulation. In particular, what is it, how does it work, and does it still make sense in today’s macro environment? Read ahead for a short primer
What is it?
In short, the Buy, Borrow, Die strategy is a wealth management approach that some wealthy Americans use to legally avoid taxes and accumulate more wealth. This strategy leverages the tax advantages of certain assets to pass on wealth without the need to liquidate or pay high tax rates. However, the strategy need not be limited to wealthy individuals. Indeed, anyone with assets and the right guidance can utilize leverage to grow wealth
How does it work?
Here is a simple overview of the three steps:
Buy: The client invests in assets that appreciate over time, such as real estate, stocks, and businesses. Importantly, these assets are not taxed until they are sold and a gain is realized.
Borrow: Instead of selling their assets and potentially incurring a high capital gains tax, these clients borrow against their assets. The loan proceeds are not considered income, so they are not taxed. Moreover, the interest on these loans can often be deducted from their taxable income.
Die: Upon the client’s death, their heirs receive the assets. The cost basis of these assets is 'stepped-up' to their market value at the time of the individual's death, which means the heirs can sell these assets without paying taxes on the gains that occurred during the deceased's lifetime. Any outstanding loans can be paid off using the assets, and the estate tax liability could be significantly lower than the capital gains tax would have been if the assets had been sold during the individual's lifetime.
Does it still make sense in today’s rate environment?
The Buy, Borrow, Die strategy could become less viable or attractive in a high interest rate environment, but that does not necessarily mean it is entirely nonviable. Here's why:
The success of the Buy, Borrow, Die strategy largely hinges on being able to borrow against assets at low interest rates. When interest rates rise, the cost of borrowing increases. This means the client would have to pay more in interest to maintain their loans, which could potentially erode the benefits of the strategy.
However, there are a few considerations that might still make the strategy attractive for some:
Asset Appreciation: If the assets are appreciating at a rate that is significantly higher than the interest rates, it could still make sense to hold on to them and borrow against them. The net gain (asset appreciation minus interest costs) would still be positive.
Tax Considerations: Even with higher interest rates, the tax advantages can still make this strategy viable. The loan proceeds are still not considered taxable income, and the potential step-up in basis upon death can still eliminate the capital gains tax liability.
Access to Cheaper Capital: Sora Finance helps provide access to credit at rates that are lower than a client might expect. So even in a high interest rate environment, clients might still be able to secure relatively cheap loans.
Hedge against Inflation: In a high interest rate environment, there's often high inflation as there is today. Hard assets like real estate and certain types of stocks can serve as a hedge against inflation. So borrowing to invest in such assets could still be attractive.
What are the risks?
It's important to stress that this is a complex strategy that involves risk, especially in a changing economic environment. As interest rates increase, so does the cost and risk associated with debt. If asset prices fall or if the individual becomes over-leveraged, they could face significant financial challenges.
Additionally, this strategy is based on current tax laws, which are subject to change. Potential changes to tax law, including changes to the capital gains tax, the estate tax, or the step-up in basis rule could impact the effectiveness of this strategy.
As with all financial strategies, individual circumstances, risk tolerance, and the specific dynamics of the asset and credit markets all play crucial roles. Professional advice should always be sought when considering such strategies.