Mastering Wealth: The Buy, Borrow, and Die Strategy Explained
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Chapter 1: Understanding the Strategy
Have you ever considered how affluent individuals maintain their wealth? The answer lies in their strategic use of the U.S. tax system. The term "buy, borrow, die" was coined over two decades ago to encapsulate this approach. Essentially, wealthy individuals invest in assets, leverage those assets for loans instead of selling them, and upon their passing, their estates are transferred to their heirs.
Typically, these assets include real estate and stocks. In this article, we will delve deeper into these three crucial steps and explore how the wealthy utilize this strategy to sustain their fortunes.
Section 1.1: Acquiring Assets
The initial step involves purchasing valuable assets, such as stocks or real estate. For instance, imagine you have $100,000 in your M1 Finance account fully invested in stocks. You can borrow against this amount. The only prerequisite is maintaining a minimum of $5,000 in a taxable brokerage account.
Real estate serves as an even more illustrative example. Individuals engaged in real estate often implement the "buy, borrow, die" strategy, especially those with net worths in the hundreds of millions. Many affluent families invest in apartment complexes and commercial properties. They frequently borrow against these assets, refinance, and withdraw funds tax-free, all while the properties continue generating cash flow despite the new debt.
Because they rarely sell these properties, they avoid capital gains taxes altogether, using the assets merely as collateral for borrowing.
Have you ever wondered why real estate garners so much enthusiasm? The answer is straightforward: it is a robust asset class that typically appreciates over time, often keeping pace with or exceeding inflation. Additionally, depending on the location, real estate can exhibit less volatility compared to other investment types.
Investors also enjoy tax benefits through depreciation, which can effectively lower their taxable income. Banks are generally more amenable to lending against real estate, provided the financial metrics align favorably.
Subsection 1.1.1: Why Real Estate?
Section 1.2: Leveraging Your Assets
Now that you grasp the concept of collateral, let’s move on to the next phase: borrowing against your assets. It’s straightforward—you utilize your previously acquired assets to secure loans.
Consider a scenario where your finances are tight and you need cash urgently. If your only assets are investments in your M1 Finance account, the typical response might be to liquidate a portion of your stocks or ETFs to access the needed funds. However, as you've likely gathered by now, this would be a misstep.
You can generally borrow up to 35% of your portfolio's value at an interest rate of 2-3.5%, depending on your account type. Given the current inflation rates, this can essentially feel like free money.
According to Morgan Stanley, there has been a significant surge in borrowing against stock portfolios, which has more than doubled over the past five years.
For instance, if a commercial real estate property has a net operating income that appraises its value at $500,000, the owner could secure an 80% loan, resulting in a tax-free withdrawal of $400,000. This borrowing strategy mirrors that of stock portfolios, allowing you to avoid taxable events while still accessing cash.
The wealthy continue to amass wealth, while those with fewer resources remain stagnant.
Chapter 2: The Endgame
The first video titled "Buy. Borrow. Die. | How The Rich Stay Rich" discusses the intricacies of this strategy and how it enables the affluent to build and preserve their wealth.
When an individual passes away, their estate typically transfers to their heirs. In many cases, loans can be settled by liquidating the assets against which the loans were secured. For instance, imagine a property valued at $3 million that was originally purchased for $1 million. The heirs can either take out a loan against this asset or sell it for $3 million without incurring capital gains taxes, as they inherit it at the new valuation.
Another popular tax strategy in real estate is the 1031 exchange. This allows property owners to defer capital gains taxes when they sell one property and purchase a similar one within a designated time frame. Many real estate investors employ this tactic repeatedly, often avoiding capital gains taxes altogether.
Why doesn’t everyone adopt this strategy?
Now that you’re more familiar with the "buy, borrow, die" approach, you may question why not everyone leverages their assets to the fullest extent possible.
The reality is that financial viability still needs to be assessed. Even after securing a cash-out refinance, the underlying assets must maintain their value. If the stocks you're borrowing against decline, you may face margin calls, requiring you to maintain that 35% ratio in your M1 Finance account.
Ultimately, individual comfort levels will dictate the use of leverage, and this varies from person to person. If you plan to invest the borrowed funds to generate additional income, this strategy may prove beneficial, provided you take calculated risks.
Leverage is merely a tool.
Exercise caution in its application. Mimicking the risk profiles of real estate developers before the 2008 financial crisis may not be prudent. At that time, many developers faced calls to repay loans, finding themselves in dire financial straits, sometimes resulting in bankruptcy or foreclosure.
Therefore, it’s crucial to approach leverage with care. Numerous individuals have successfully utilized this strategy, yet many others have faced significant losses.
In my view, the optimal approach is to find a middle ground where you feel secure, even after borrowing against your real estate investments. Remember, this is not financial advice but rather my interpretation and application of this strategy on a smaller scale.
The second video titled "How To Avoid Taxes Like The Rich - Buy Borrow Die Strategy Explained" elaborates on effective tax avoidance strategies employed by the wealthy, providing further insights into the buy, borrow, die framework.