Do the Rich Really Escape Tax by Borrowing?
Run the Interest Math First
You have heard the argument. The wealthy never sell anything, so they never pay tax. They just borrow against their stock or their land, live off the loan proceeds, and let the step-up in basis wipe out the gain when they die. Buy, borrow, die.
There is truth in it. But almost nobody who repeats the argument has actually run the interest cost against the tax cost. When you do, the picture gets a lot more interesting, and the answer turns on one number that has nothing to do with the tax code.
Let me show you.
The setup
Assume a taxpayer holds $10 million of stock or farmland with a zero basis. He needs $1 million of cash to live on.
He has two choices.
Option 1: Sell and pay the tax. At the top capital gain rate of 23.8 percent (20 percent plus the 3.8 percent net investment income tax), he has to sell $1,312,336 of assets to net $1 million. The tax bill is $312,336. One time, done.
Option 2: Borrow. He pledges the portfolio and borrows $1 million at 6 percent. Interest runs $60,000 a year. If the interest is deductible at 37 percent, his after-tax cost is $37,800 a year.
The raw cash comparison
Here is what the borrowing costs him over time compared to the $312,336 tax he would have paid on day one.
