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Using Loans to Pay Estate Taxes: What is a Graegin Loan?

What happens if an estate has assets that it simply cannot sell off to meet estate tax obligations? This will usually be the case with high net worth estates and in New York, that could mean that quite a few estates might find themselves facing this problem.

Can the estate take out a loan to pay off its estate tax?

There are many expenses associated with closing an estate. In addition to court fees and administration expenses, the estate may be liable to creditors.

Sometimes, the estate simply does not have enough liquid assets to sell off in order to pay the expenses. And all that may be left are assets that won't be easy to dispose of -- perhaps shares of a closely held corporation that are not marketable.

The estate might still have a value above and beyond the applicable estate tax exemption amount (i.e. the estate might be asset rich but cash poor). As such, it might be liable for estate tax based on how rich the estate looks on paper.

Some estates are trying something out called a Graegin loan. The Graegin loan takes its name from a case called -- you guessed it, Estate of Graegin. This type of loan is a loan taken out by the estate for the purposes to pay administration expenses. It's usually taken out by the estate from a related entity, usually an entity that the estate owes a part of.

There are many requirements to taking out this type of loan. The one big reason that many estates may consider taking out this type of loan is because if done properly, the estate can take a full up-front deduction on the interest payable under the loan.

Not the interest paid. The interest payable. That essentially means the interest that the estate estimates paying over the entirety of the loan.

Imagine how much an estate's tax burden could be reduced if it were able to deduct the full amount if interest on such a loan up front.

In order to have a valid Graegin loan, the loan needs to be a real loan, i.e. it needs to be bona fide. There has to be a reasonable expectation that the loan will be repaid (a proper loan contract with real enforceable terms). There should also be no early payment allowed of the loan, as this would help make the interest amount more ascertainable. Finally, the loan needs to be necessary. These loans can't be taken out randomly. They need to have the purpose of "saving" the estate from having to liquidate its non-marketable assets.

If you're administering an estate and are interested in a Graegin loan, any good estate planning attorney should be able to guide you on this.

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