Can a Trust Take Out a Loan? A Detailed Guide

Taking out a loan can seem like a straightforward way for a trust to access funds, but it’s not as simple as it may appear. Loans from trusts can be valuable financial tools when done correctly, but they also come with complications. This guide will walk through everything you need to know about trusts taking out loans.

What is a Trust?

Before diving into trust loans, let’s start with a quick overview of what a trust actually is. A trust is a legal entity that holds assets for the benefit of certain people or entities called beneficiaries. The person who creates the trust and contributes assets is called the grantor or settlor. The trustee is responsible for managing the trust and carrying out its terms.

Trusts can be revocable or irrevocable. With a revocable trust, the grantor retains control and can amend or even dissolve the trust An irrevocable trust cannot be changed once created. Assets in an irrevocable trust are permanently transferred out of the grantor’s ownership

Can a Trust Take Out a Loan?

The short answer is yes, trusts can take out loans under certain conditions. But there are several factors to consider:

• Type of trust – Rules differ for revocable vs. irrevocable trusts. Most loans are taken out by irrevocable trusts.
• Loan terms and conditions – Interest rates, collateral, loan amount, and repayment terms need to be carefully set.
• Trust powers – The trust document must authorize borrowing.
• Trustee approval – Trustees must agree the loan aligns with the trust’s purpose.
• Beneficiary notification – Beneficiaries may need to be informed of trust loans.

While trusts can borrow money, loans should be examined closely to avoid legal issues or tax complications. Proper implementation is key.

Revocable vs. Irrevocable Trust Loans

Revocable Trust Loans

In a revocable trust the grantor retains full control. This generally allows flexibility to take loans

• During life, the grantor can amend the trust terms to permit borrowing.
• Loans can be taken from the grantor personally without restrictions.
• After death, once the trust becomes irrevocable, loan options are more limited.

Revocable trusts rarely need loans since the grantor still personally owns all assets Loans are more common with irrevocable trusts

Irrevocable Trust Loans

Irrevocable trusts have fixed terms that cannot be changed by the grantor after creation. This limits loan options but loans are still possible if:

• The trust document authorizes borrowing power.
• The loan aligns with the trust’s purpose and benefits beneficiaries.
• Trustees and other parties approve the loan.
• The loan has proper terms and conditions.

Key considerations for irrevocable trust loans include the loan amount, interest rate, collateral, and repayment plan. These impact whether the loan is deemed “arm’s length” or a disguised gift.

Loan Requirements and Conditions

Trust loans must meet certain requirements to be valid and avoid legal issues. Key loan conditions include:

Trust Loan Authorization

• The trust document must authorize the trustee to take loans. If borrowing power is not already granted, the trust may need to be amended by the grantor (for revocable trusts) or trust protector (for irrevocable trusts) to permit loans.

Permitted Loan Purposes

• Loans should align with the overall trust purpose and benefit the beneficiaries. Loans cannot conflict with fiduciary duties.

Trustee Approval

• The trustee(s) must provide formal approval for any trust loans. Unanimous consent is often required for co-trustees.

Beneficiary Notification

• Trust beneficiaries may need to be informed of loans, especially if loan terms favor one beneficiary over others. Written acknowledgement is ideal.

Arm’s Length Terms

• Loans should have arm’s length terms – market interest rates, adequate collateral, and reasonable repayment plans – to avoid disguised gift risks. Exceptions can be made for beneficiary loans.

Loan Documentation

• Formal loan documents should be executed – promissory notes, security agreements, etc. Terms and conditions should be clear.

Common Trust Loan Situations

Some examples of when trusts may need loans include:

• Liquidity needs – Accessing cash for expenses when trust assets are illiquid.
• Investments – Borrowing to invest in other assets like real estate.
• Beneficiary needs – Providing finances to beneficiaries for large purchases.
• Grantor loans – Loan from grantor for gifting purposes if authorized.
• Defective trusts – Allowed with intentionally defective grantor trusts.

The most common scenario is loans to beneficiaries – often the grantor’s children – for major expenses like a home purchase.

Tax Implications of Trust Loans

There can be tax ramifications to trust loans in certain situations:

• Loans from non-grantor trusts to the grantor may trigger grantor trust status, eliminating tax advantages.
• Forgiveness of principal or interest could be considered income to the borrower.
• Interest rates below IRS minimums could result in gift tax liability.
• Improper loans could lose estate tax benefits and trust assets may be includible in the grantor’s estate.

Proper structuring is important to avoid adverse tax consequences. An experienced attorney and accountant should advise on any tax-related trust loan matters.

In Summary

While trusts can generally borrow funds, loans involve complex legal and tax considerations. Key takeaways include:

• Trust terms must allow borrowing power.
• Loans should align with the trust purpose and benefit beneficiaries.
• Trustees must formally approve all loans.
• Arm’s length terms are ideal to avoid unintended tax and legal outcomes.
• Seek experienced counsel to ensure loans adhere to all requirements.

When executed properly, loans can serve as useful tools for trusts to access funds. But due diligence is required. Consult with knowledgeable advisors before moving forward with any trust loans to avoid potential pitfalls.