What if I told you there was a way to sell an appreciated asset without paying any capital gains tax?
And it could be nearly any asset — an investment property, Apple’s stock, crypto — pretty much anything. You name it.
Well I’m here to show you the way.
It’s called the Buy Borrow Die Strategy and it’s been used by high net worth individuals for decades to access liquidity, balance their portfolio and avoid huge tax bills on appreciated assets.
How to Execute The Buy Borrow Die Strategy
Buy, or invest, in an asset. The strategy works best with well known, low risk assets such real estate, but can also be used with stocks, bonds, crypto and other securities.
Next: wait for that asset to appreciate in value …. then ….
Borrow against the value of the appreciated asset. Don’t sell it and pay capital gains tax (and/or depreciation recapture tax). Instead, borrow against the higher value of the asset to unlock the liquidity you need.
Die. It sounds morbid, but thanks to the Step Up in Basis tax rules, when someone dies and leaves an asset to an heir, the tax basis resets to the fair market value of the asset on the day of death.
Let’s peel back the onion and look at each step in a bit more detail.
Step 1: Buy an asset and let its value appreciate over time
The first step is to invest in an asset. This is the easiest part of the strategy.
Over long periods of time, most assets will appreciate in value.
The key here is to balance risk.
Since you will be borrowing against the appreciated value of the asset (see step 2 below), you don’t want to pick an asset that has a lot of price volatility. Especially if that asset does not produce a dividend or other form of current income.
It can be dangerous to pay interest on an asset that doesn’t produce any cashflow.
For that reason, I strongly recommend investing in real estate. Real estate has proven to generate strong, risk-adjusted returns over long periods of time, and is typically much less volatile than other, perhaps more liquid assets, like stocks.
Furthermore, real estate offers you the ability to use current rental income to satisfy your debt obligation. In other words, if your rental income can cover your principal and interest payments, then the value of the underlying asset is meaningless, for purposes of this strategy.
Step 2: Borrow against the value of the appreciated asset
The second step is to take out a loan against the appreciated value of the asset.
You decide, for whatever reason, that you want liquidity from your investment.
Some common examples for when you might want the liquidity are:
- A major life event that requires significant capital (eg. purchasing your first home)
- Another investment opportunity you can’t pass up (eg. starting a business)
- Over concentration of wealth in a single appreciated asset (eg. Bitcoin shoots through the roof)
Whatever the reason may be, you have two options. You can either sell the asset, and pay the capital gains tax, or borrow against the asset, avoid the tax altogether, and still retain ownership.
Let’s Look at a Simple Example:
- You purchased an investment property for $500,000 and took out a mortgage (loan) to cover $400,000 of the purchase price (80%).
- You put down the other $100,000 in cash.
- 5 years pass by and the value of the property has appreciated to $750,000 (~8% annual return).
- Meanwhile, you’ve made your monthly mortgage payments on-time, so the principal balance on your 30-yr mortgage has decreased to $350,000.
- You decide you need liquidity.
So what should you do?
Option 1: Sell
If you sell the property for $750,000, you will keep $400,000 after paying off the mortgage. But you will owe some tax. You will show a $250,000 capital gain ($750,000 sale price less $500,000 purchase price) so you will owe ~$50,000 in long-term capital gains tax (assuming a 20% rate for simplicity).
Cash Invested: $100,000
Cash Received at Sale: $350,000
Option 2: Borrow (Refinance)
Now what if instead of selling the property, you refinance based on the asset’s appreciated value of $750,000. We’ll assume the lender gives you 80% of the appreciated value of the property.
$750,000 (x) 80% loan to value = $600,000 mortgage.
You receive $600,000 in cash from your lender. After paying off the original loan, with a current balance of $350,000, you are left with $250,000 in your pocket.
And guess what… since the proceeds are from debt issuance — and not from a sale — you don’t pay any tax on that $250,000. Nothing.
Cash Invested: $100,000
Cash Received at Sale: $250,000
Which is the Better Option?
From that example you may be thinking to yourself, wait, why is Option #2 better?
Clearly the ROI — or return on investment — is lower. So what am I missing?
Remember, in option #2 you never sold the asset. It’s still yours. As a result, overtime, you continue to benefit from:
- Appreciation in the underlying value of the asset
- Cashflow generated from your net rental income, and
- Principal paydown on the mortgage
In other words, you were able to pull out 2.5x the cash you invested in the deal in the first place AND you continue to reap the ongoing benefits of real estate ownership.
You essentially generated an infinite IRR — internal rate of return — and can now recycle the cash you used to buy the asset in the first place to go out and acquire more assets.
Rinse and repeat. That’s the secret…
Continue to buy real estate assets with leverage, refinance when the property appreciates in value, pull out your initial equity (if not more, like in this example) and use those proceeds to repeat the process over and over again, for decades
The endgame? A multi-million dollar real estate empire to pass on to the next generation. Which leads me to third and final step of the Buy, Borrow, Die Strategy…
Step 3: Die and let your heirs benefit from the step up in basis
The third and final step is to die.
As morbid as that sounds, when you die your assets will pass on to your heirs as outlined in your estate planning documents. At the same time, the tax basis of your assets will reset based on their current fair market value.
So back to our prior example, if, for example, you died the day before you went to sell your investment property, its tax basis would reset to $750,000, the current value of the property. When your heirs go to sell, they would pay no capital gains tax on the first $750,000 of proceeds.
At this point your mind is probably racing.
Just imagine the power of this reset 20, 30, 40 years from now.
Properties you purchased today for $750,000 may be worth $2 or $3 million dollars one day. When you pass away your heirs will inherit those properties and have the basis reset.
This can be the difference in millions and millions of tax dollars.
And remember, if your chosen asset is real estate, you’re likely continuing to benefit from ongoing cashflow during your lifetime, much of which can be non-taxable through the benefits of depreciation. It is truly a win-win for you and your heirs.
Common Loan Types
There are a variety of different loan types that may be appropriate for the Buy, Refi, Die Strategy, depending on the assets you own and your unique situation.
💡 Pro Tip: The majority of the time a Cash-out Refinancing is the best way to execute the Buy, Borrow, Die Strategy. You will only want to consider an alternative approach if you are borrowing against non-real estate assets or have existing mortgages in place with super low interest rates.
In general, using leverage against any asset, other than real estate, involves a high degree of risk.
However, if applied conservatively, both a Margin Loan and Securities Backed Line of Credit can be very effective for long-term wealth planning. I would strongly advise consulting an experienced wealth manager if you are interested in borrowing against your securities portfolio.
What is a cash-out refi?
A cash-out refinancing allows you to take on a larger mortgage in exchange for accessing the equity in your home. Essentially you are taking on more debt (based on your property’s appreciated value) and using that debt to payoff the lower balance on your first mortgage. You get to keep the balance between those two mortgages (and pay no tax!).
- Lower Interest Rates: Because a cash-out refinancing pays off your original mortgage and assumes a 1st lien position, this type of loan will offer a lower interest rate than a Home Equity Loan.
- Complete Payoff: A cash-out refinancing requires you to pay off your property’s current mortgage. This can be a good thing if interest rates have fallen, but a bad thing if interest rates have increased.
Home Equity Loan “HEL”
What it a Home Equity Loan?
A Home Equity Loan allows you to borrow against the equity in your home. This is different from a cash-out refinancing in that you are taking a 2nd lien against the property. You are not paying off the original mortgage.
However, it is similar to a cash-out refinancing in that you are accessing tax free proceeds from your home equity that can be reallocated for other use cases, including acquiring additional real estate.
- No Payoff: With a Home Equity Loan you are not paying off your existing mortgage. This loan type allows you to keep your original mortgage in place while still accessing the built up equity in your home. This can be a good thing if interest rates have increased overtime.
- Higher Interest Rates: A Home Equity Loan will often require paying a higher interest rate than a Cash-Out Refi because the loan is in second position. Every month you will still have to pay the original mortgage, in addition to your new HEL.
What is a Margin Loan?
A Margin Loan allows you to borrow funds against the value of your investment portfolio, traditionally marketable securities such as stocks, bonds, ETFs and mutual funds.
Proceeds from a Margin Loan are often used to buy more investment securities, which is not allowed under a Securities Backed Line of Credit.
- Increased Buying Power: a proven strategy, particularly for younger investors, is to take out a Margin Loan on your investment portfolio and use the proceeds to purchase additional shares. For example, if you own $100,000 of Apple stock, you can open a margin account and invest an additional $100,000 in Apple stock using the bank’s capital. This strategy can be quite effective during market downturns when you have high conviction in the long-term merits of an investment and you are looking to capitalize on short-term price volatility. As you can imagine, this can be a risky strategy. But for investors with time on their side, and a high risk tolerance, adding modest amounts of leverage to your investment portfolio can enhance long-term returns.
- Low Loan-to-Value: Since there is often more price volatility with marketable securities, Margin Loans are often capped at 50% of the overall account value. In the example above, this means if you own $100,000 of Apple stock, you can take out up to $100,000 in a Margin Loan. This 50% cap is known as the Advance Rate and varies by institution.
- Margin Call: Lenders reserve the right to require you to add additional capital if your overall account value falls below a certain threshold. This threshold also varies by institution. If you do not add capital, the bank can sell your assets, triggering a taxable event.
Securities Backed Line of Credit “SBLOC”
What is an SBLOC?
A Securities-Based Line of Credit “SBLOC” allows you to borrow against the appreciated value of your your investment portfolio, traditionally marketable securities such as stocks, bonds, ETFs and mutual funds.
Unlike a Margin Loan, you are not allowed to use the proceeds from an SBLOC to purchase investment securities. Instead, SBLOC proceeds can be used for a variety of other needs such as buying real estate, starting a business, or meeting short-term tax liabilities, etc.
- Flexibility: SBLOCs are set up as revolving lines of credit (similar to a credit card). They can be easily paid down and redrawn based on your specific needs. Unlike a Margin Loan, an SBLOC is non-purpose in nature, meaning you can use the proceeds for pretty much anything (except for buying more investment securities). For that reason an SBLOC is a great way to help rebalance your portfolio in the event one asset has dramatically appreciated. It can also be very effective to help meet any short-term capital requirements that you intend to repay.
- Tax Efficiency: An SBLOC can be a good tool to push taxes on highly appreciated assets to a more tax-efficient time. For example, perhaps you want to access liquidity from a highly appreciated stock position that you entered 10 months earlier. Rather than sell the stock and pay short-term capital gains tax based on your ordinary income tax bracket, you can use an SBLOC to access liquidity immediately. You will then wait 2 months to sell the asset, after the 1 year mark, at which point you would be taxed at the more favorable long-term capital gains rate.
- Lower Interest Rates: It is quite common for SBLOC’s to have a lower interest rate than Margin Loans. They are typically priced based on the London Interbank Offered Rate (“LIBOR”).
- Non-purpose: For the most part the primary disadvantages are the same as with a Margin Loan. The only unique disadvantage is the inability to use an SBLOC to buy additional investment securities. You should pursue a Margin Loan if that is your primary objective.
What is the 6 Month Rule and how does it relate to a Step Up in Basis?
The 6 month rule allows the executor of a deceased person’s estate to designate an “alternate valuation date” for the assets of the estate. This basically means if you die tomorrow, the date upon which the fair market value is based can be six months into the future. This is particularly useful if you pass in the middle of a market bull run.
The alternate valuation date will apply to ALL assets in the estate. Unfortunately you cannot pick and choose your favorites. Use IRS Form 706 to set an alternate valuation date.