The Graegin Loan

Many, if not most, large estates fall at least somewhat short of having all the liquidity needed to pay federal and state estate taxes. While there may, in some situations, be structures already in place (e.g. a funded “buy/sell” agreement) this is not always the case, or may not be sufficient. Those taxes are, generally, payable with the estate tax return nine months after the date of death.

Fire Sale?

Of course, an asset sale can raise the needed liquidity, but closing the chapter on a life’s work might also be emotionally difficult and even contrary to the family’s wishes. As a practical matter, the sale might involve assets that generate income for the family, creating cash flow and lifestyle issues. Additionally, assets like closely held family business interests, real estate holdings, etc. can be difficult to liquidate in a short time frame, creating a “fire sale” atmosphere that erodes the proceeds and forces additional sales.

The Graegin Loan

Another option exists. Named after a tax court case, the Graegin loan serves three functions. It generates cash to pay the estate tax, it keeps the assets (and their cash flow) with the family, and reduces the size of the taxable estate. The power of the Graegin loan is that the full amount of the interest that will be paid over term of the loan is taken as a current deduction, dollar for dollar, from the gross estate. For example, if an estate borrows $10 million at 5% interest on a ten-year note, the loan can be structured with all principal and interest deferred until a balloon payment at the end of the term. Up front, the entire $5 million of interest ($10mm x 5% x 10 = $5mm) would be deductible from the gross estate, creating an estate tax savings of at least $2mm(1).

As it is a product of case law, a successful Graegin loan must follow certain “generally accepted” guidelines, among which are:

• Fully document the estate’s need for liquidity.

• Provide loan structure detail making it clear that the interest due is transparently calculable and likely to be repaid.

• Make sure the terms are reasonable and at market levels as to all parties.

• Note that when there is a relationship between the borrower and the lender these loans will be given greater scrutiny by the IRS. In this regard there is a case to be made for a third-party commercial lender.

For the right reasons and in the right circumstances a Graegin loan can be a very effective post-mortem estate planning device.

1. Note that these loans by their terms cannot be prepaid (unless at that time all interest payable on the full note would be due.)

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Nicholas Bertha
Director of Wealth and Trust Planning, Fieldpoint Private Securities, LLC