Tax Planning 101: Buy, Borrow, Die

Every fan of Christopher Nolan knows that any good magic trick contains three acts. The first act is the pledge, where the magician does something ordinary. Then comes the turn, where the ordinary becomes extraordinary. The third act is the prestige, returning the extraordinary to the ordinary.

In order to avoid taxation using Buy, Borrow, Die, an American must first have enough money to invest in appreciating assets. Broadly invested assets often provide at least 3% growth every year after inflation, which means that $2 Million invested provides an annual passive income of about $60,000, the median American household salary. $10 Million invested provides approximately an annual passive income of $300,000, which is well into the 90th percentile of earners. This is gained through no effort of the investor. If the taxpayer sells these gains as she receives them, then she will pay capital gains taxes. (already a lower rate than the normal income rates)

By using this strategy, our Patriotic American Citizens don’t even need to pay the lower capital gains taxes. Instead, they can peacefully protest the American government’s oppressive taxation regime, leaving the expense of roads and hospitals and public education to their less-propertied counterparts, instead spending their wealth on hard-earned vacations and yachts.

The Pledge: Buy

The first act of this magic trick is very simple. Our Patriotic American Citizen takes their hard-inherited wealth and buys appreciating assets. $10,000,000 inherited will usually provide at least $600,000 in gains, approximately $300,000 of which will be saved so that the fund grows with inflation, leaving $300,000 of income (which grows with inflation, because the other $300,000 is saved). But that is not sold; the first step is buy, not sell.

The Turn: Borrow

The second act is also very simple. Our Patriotic American Citizen now wants to spend her $300,000 in income from above, which logically would mean selling the gains and paying 15% capital gains taxes on their income.

The Patriotic American Citizen here turns the ordinary (spending $300,000 in capital gains) into the extraordinary by withdrawing $300,000 in debt. By doing so, she has avoided paying taxes this year on her capital gains, because they have not been sold and are therefore unrealized, and she has avoided paying taxes on the debt because debt is not taxed. She has paid no taxes this year, despite spending the $300,000 in appreciation of her assets.

This part of the trick is repeated every year, until it is time for the final act.

The Prestige: Die

Our Patriotic American Citizen has allowed her unrealized gains to accumulated over the course of her life. This should mean that they are all taxed when they are finally sold, but therein lies the final sleight of hand; they are never sold. Instead, the Patriotic American Citizen dies, still owning the assets.

At this point, the extraordinary again becomes the ordinary. The appreciated assets are now at a stepped-up basis, washing away the unrealized gains. They are then sold, without any built-in taxes, so the estate pays no taxes on the total amount, including not only the initial investment but also the appreciation of the asset. The estate then uses the appreciation of the assets to pay off the debt. The principal remains.

The result, therefore, is a life without taxes. The principal investment provides, through appreciation, additional wealth, which the Patriotic American Citizen then matches in debt. When the Patriotic American Citizen dies, the whole wealth is sold, tax-free, and the debt is paid with the tax-free proceeds. The principal remains and is invested for the descendants of our Patriotic American Citizen, who will follow Buy/Borrow/Die in order to avoid paying taxes on their income from these investments.

Next: Read an overview of the tax lesson