The United States federal income tax contains a flaw: Because it reaches capital gains only after a “realization” event, it permits owners of highly appreciated assets to defer their tax liability by holding them and refusing to sell. Worse yet, easily available debt allows those owners to consume from their “unrealized” gains while continuing to defer tax. As Professor Edward McCaffery identified in 2012, consumption and deferral through secured borrowing, coupled with the stepped-up basis death benefit from section 1014 of the Internal Revenue Code, create an opportunity for individuals to avoid lifetime income tax and net estate tax. This strategy, known as “buy/borrow/ die,” contributes to consumption inequality and, by extension, America’s growing wealth inequality.
In the tax literature, buy/borrow/die has served as a helpful hook for supporters of wealth taxes, mark-to-market income taxes, and the repeal of section 1014’s stepped-up basis provision. But these three solutions merit some pragmatic concern, on the grounds that they are (to varying degrees) possibly unconstitutional, likely to be repealed, or publicly unpopular. Recognizing those practical obstacles should steer policymakers toward an incremental second-best solution: treating borrowing against appreciated collateral as a realization event. Embracing a “realization at borrowing” policy would reduce the availability of buy/borrow/die as a tax reduction strategy while sidestepping the hurdles that other proposed solutions must clear.
