Got Liquidity Problems in your Estate Administration? How to navigate in this rising rate environment.

Graegin loans are loans that can be used to pay estate tax and estate administration expenses. Under the right circumstances, a Graegin loan can provide low-liquidity estates with the ability to both defer and reduce estate tax liability.
Read the Full Story

Got Liquidity Problems in your Estate Administration? How to navigate in this rising rate environment.

Graegin loans are loans that can be used to pay estate tax and estate administration expenses. Under the right circumstances, a Graegin loan can provide low-liquidity estates with the ability to both defer and reduce estate tax liability.

Whether or not you file an estate tax return or extension, estate taxes are generally due within 9 months from the decedent’s date of death. This creates an interesting predicament for people with taxable estates, as they usually hold most of their net worth in illiquid assets like businesses, real property, and investment products that do not provide daily liquidity. 

This chicken-egg issue does not only affect the wealthy.  For people with non-taxable estates, a lack of liquidity in the estate to pay off estate administration expenses can become a huge problem. A common example of this (and one that we see every day) is when an estate consists of a home and very little of anything else, and the estate cannot afford to pay the carrying costs of that property (HOA fees, condo assessments, maintenance/ management fees, property taxes, insurance, etc.) and there are restrictions on the sale of the property (for instance, a restrictive covenant in the condo bylaws barring a sale if the fees aren’t fully paid up, etc.), thereby making it impossible to sell the property without paying off the expenses, yet there is no cash in the estate until the property can be sold.  

The Graegin Loan - A Liquidity Solution

Though loans to the estate in general are a good solution to this liquidity problem, one particularly great option in this rising interest rate environment that can be used for estates in this situation is a Graegin loan. Graegin loans are loans that can be used to pay estate tax and estate administration expenses. Under the right circumstances, a Graegin loan can provide low-liquidity estates with the ability to both defer and reduce estate tax liability.

Graegin loans get their name from a tax court case called Estate of Graegin v. Commissioner (56 T.C.M. 387 (1988)), where an estate prevailed against the IRS. In this case, the estate took out a loan to pay the estate tax, and (very intelligently) deducted the interest from the loan as an estate administration expense under Code Sec. 2053. This was a smooth move, as it significantly reduced the estate tax owed in the first place (interest rates at the time were high and the note had a 15% fixed rate). The IRS tried to fight the, and the estate (i.e., the taxpayer) won. 

How do you get a Graegin loan? 

Graegin loans can be issued by a financial institution or other third parties. In order for the interest to remain a deductible estate administration expense, the loan has to meet three requirements: 

1. Must be a bona fide loan. 

       a. Thus, if it’s financed at less than arm’s length (i.e. where the lender is a wealthy family member), it is going to be heavily scrutinized.

       b. If it has unusual terms, i.e. a higher than usual interest rate, an unusually long term, inadequate collateral, it is going to be heavily scrutinized.

       c. The lender must recognize the loan interest payments as income. 

2. A majority of the estate assets are illiquid and borrowing is necessary to avoid a forced sale of those assets to pay estate tax. 

Therefore, if the loan is a commercial loan, at a fixed and reasonable rate of interest, the IRS can only attempt to establish that the estate wasn’t as illiquid as it is purported to be and the loan was unnecessary.

Why does this matter right now?

As we are in a rising rate environment, the deductibility of the interest payment has become increasingly important, particularly for taxable estates. 

In order to deduct the full interest amount as a cost of administration before the interest is actually paid (i.e., 9 months after the decedent’s death when an estimated tax payment must be made), the terms of the note for the Graegin loan must contain:

  1. A fixed interest rate; 
  2. A prohibition against prepayment; and 
  3. An immediate acceleration of all interest that would have been payable on the note upon default.

Read the Full Story

Got Liquidity Problems in your Estate Administration? How to navigate in this rising rate environment.

Graegin loans are loans that can be used to pay estate tax and estate administration expenses. Under the right circumstances, a Graegin loan can provide low-liquidity estates with the ability to both defer and reduce estate tax liability.
Read the Full Story
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Got Liquidity Problems in your Estate Administration? How to navigate in this rising rate environment.

Trustate Team
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Whether or not you file an estate tax return or extension, estate taxes are generally due within 9 months from the decedent’s date of death. This creates an interesting predicament for people with taxable estates, as they usually hold most of their net worth in illiquid assets like businesses, real property, and investment products that do not provide daily liquidity. 

This chicken-egg issue does not only affect the wealthy.  For people with non-taxable estates, a lack of liquidity in the estate to pay off estate administration expenses can become a huge problem. A common example of this (and one that we see every day) is when an estate consists of a home and very little of anything else, and the estate cannot afford to pay the carrying costs of that property (HOA fees, condo assessments, maintenance/ management fees, property taxes, insurance, etc.) and there are restrictions on the sale of the property (for instance, a restrictive covenant in the condo bylaws barring a sale if the fees aren’t fully paid up, etc.), thereby making it impossible to sell the property without paying off the expenses, yet there is no cash in the estate until the property can be sold.  

The Graegin Loan - A Liquidity Solution

Though loans to the estate in general are a good solution to this liquidity problem, one particularly great option in this rising interest rate environment that can be used for estates in this situation is a Graegin loan. Graegin loans are loans that can be used to pay estate tax and estate administration expenses. Under the right circumstances, a Graegin loan can provide low-liquidity estates with the ability to both defer and reduce estate tax liability.

Graegin loans get their name from a tax court case called Estate of Graegin v. Commissioner (56 T.C.M. 387 (1988)), where an estate prevailed against the IRS. In this case, the estate took out a loan to pay the estate tax, and (very intelligently) deducted the interest from the loan as an estate administration expense under Code Sec. 2053. This was a smooth move, as it significantly reduced the estate tax owed in the first place (interest rates at the time were high and the note had a 15% fixed rate). The IRS tried to fight the, and the estate (i.e., the taxpayer) won. 

How do you get a Graegin loan? 

Graegin loans can be issued by a financial institution or other third parties. In order for the interest to remain a deductible estate administration expense, the loan has to meet three requirements: 

1. Must be a bona fide loan. 

       a. Thus, if it’s financed at less than arm’s length (i.e. where the lender is a wealthy family member), it is going to be heavily scrutinized.

       b. If it has unusual terms, i.e. a higher than usual interest rate, an unusually long term, inadequate collateral, it is going to be heavily scrutinized.

       c. The lender must recognize the loan interest payments as income. 

2. A majority of the estate assets are illiquid and borrowing is necessary to avoid a forced sale of those assets to pay estate tax. 

Therefore, if the loan is a commercial loan, at a fixed and reasonable rate of interest, the IRS can only attempt to establish that the estate wasn’t as illiquid as it is purported to be and the loan was unnecessary.

Why does this matter right now?

As we are in a rising rate environment, the deductibility of the interest payment has become increasingly important, particularly for taxable estates. 

In order to deduct the full interest amount as a cost of administration before the interest is actually paid (i.e., 9 months after the decedent’s death when an estimated tax payment must be made), the terms of the note for the Graegin loan must contain:

  1. A fixed interest rate; 
  2. A prohibition against prepayment; and 
  3. An immediate acceleration of all interest that would have been payable on the note upon default.

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