How the Rich Use Loans to Pay Estate Taxes Without Selling Their Inheritance
- Cash-poor but asset-rich families can use loans to pay property taxes rather than selling inherited assets.
- For those with illiquid estates, they can even deduct interest and save millions on estate tax.
- Four lawyers tell Insider how loans can help families preserve wealth and pay Uncle Sam less.
Nothing is certain except death and taxes. But for wealthy Americans, there are ways to change how much you pay in estate tax and when — if you have a savvy financial advisor.
Currently, a 40% federal estate tax applies to estate values exceeding $12.06 million for singles and $24.1 million for married couples. When a person dies, their heirs have nine months to file a federal tax return if their inheritance meets these minimums.
Some of the wealthiest are asset-rich but cash-poor, with their wealth tied up in illiquid assets such as real estate or private businesses. They can rush to sell those assets to meet the nine-month deadline, or take out a loan, whether from a bank or a trust, to pay Uncle Sam.
“Obviously you have to pay inheritance tax, but in the meantime you don’t have to sell potentially income-generating assets at full price, and you can use the income from those assets to repay the interest on the loan” , explained Jere Doyle, senior vice president and estate planning strategist at BNY Mellon Wealth Management.
Additionally, if illiquid assets are at least 35% of the value of the estate, families can defer estate tax for up to 14 years, paying in installments with interest and effectively taking out a government loan. .
Insider spoke to four lawyers to find out how the wealthy can use loans to keep family businesses and other illiquid assets and even save millions on property taxes.
Loans are great for saving assets that are likely to appreciate, but there are a lot of hurdles to jump through
Most banks are reluctant to provide loans to estates. “Nobody wants to line up with estate creditors,” said Jose Reynoso, senior managing director of Clarfeld Citizens Private Wealth.
But taking out a loan from a related party is often in the best interests of the family. If the loan is made by a related party, such as a family limited partnership or a trust funded by the deceased’s life insurance, the estate essentially pays off the loan.
“It’s a win-win-win,” Doyle said.
For another win, estates can take out a Graegin loan to pay estate taxes and subtract interest up front from their tax burden. The technique is named after a 1988 tax court that ruled that interest payable on a loan to pay estate tax was deductible up front. Graegin loans are only used for large estates, so the interest savings are considerable.
Here’s how a Graegin loan might work in practice, according to Doyle:
The heirs of a $10 million estate could be liable for $4 million in federal estate taxes. If they use a Graegin loan with $1 million in interest, the full amount can be deducted upfront on the tax return. The taxable estate is $1 million lower, which means the family will save $400,000 in estate taxes at the 40% tax rate.
The family is still responsible for the interest on the loan, and the net cost after estate tax savings will be $600,000, but these installments are paid over the term of the loan. In the meantime, the family can hold on to appreciating assets and use their cash to repay the loan.
However, Graegin loans come with a lot of conditions. It must be shown that the debt is bona fide – that there is a genuine expectation of repayment and an intention to enforce collection of the debts. The estate must also show that the loan is necessary to pay taxes and administrative costs in order to avoid a forced sale.
Graegin loans are rare and subject to scrutiny by the IRS
Graegin loans are rare and usually a last resort, according to Eric Mann, partner at Neal Gerber Eisenberg. For example, loans may become necessary if the client has worked with an “aggressive” investment manager who has over-allocated highly illiquid assets like private equity.
“Graegin loans come when you have a situation where someone died, someone who didn’t do enough planning and surrounded themselves with inappropriate professionals, and now they have a
problem,” said Mann, who typically works for clients worth at least $100 million.
Graegin loans are prime targets for auditors, lawyers warn, which is part of why they avoid them. The IRS is taking some families to court.
For example, the estate of John F. Koons, III, a Pepsi distributor, claimed a $71.4 million deduction on a $10.75 million loan from an LLC controlled by the heirs. After a years-long legal battle decided in 2017, the court ruled the loan was not necessary because the heirs could have used LLC funds to pay taxes. After interest, the estate owed an additional $42.78 million in estate tax to the IRS.
Loans to repay inheritance taxes could become more popular after the halving of the inheritance tax exemption in 2026
Thanks to the tax law passed in 2017 by Republicans that doubled the asset threshold for federal gift and estate tax, very few Americans have to worry about estate taxes. According to the latest available data from the IRS, only 3,441 estate tax returns were filed in 2020 and only 1,275 were taxable.
With appraisal discounts, a married couple could potentially pass on $36 million in assets without paying federal estate tax, according to Robert Strauss, partner at Weinstock Manion.
“It’s a rich person’s playground problem,” Strauss told Insider.
But the upper tax threshold is set to expire in 2026 at $5 million, adjusted for inflation from 2018. More households will owe property taxes, and loans to pay them could become more popular.
“Perhaps smaller businesses will be affected, less sophisticated business owners who haven’t sought as much outside planning advice and hadn’t had a chance to build up cash outside of what the business generates,” Reynoso said.
But it is difficult to predict whether the sunset will actually occur. Strauss believes that by 2026, the presidency and Congress will be controlled by the Republican Party, which would be inclined to extend the exemption.