How Do I Get Refinancing for Property in an Irrevocable Trust?

What happens when homeowners don’t ever move?  Eventually, the home passes to their heirs after death.  For child beneficiaries, they end up with a pretty good deal.  There’s the classic loophole step-up in tax basis, as well as an exemption from property tax reassessment for parent/child transfers. 

But wait, what if there are multiple children?  They’d all inherit the home together, get their step-up in tax basis and live happily ever after, right?  Well I wish there were always fairy-tale endings, but it’s really not a surprise that usually one or more child doesn’t want to live in or manage the property and prefers to cash-out: get a loan, get a payout, get taken off title, then live happily ever after, right? 

Unfortunately, there is no property tax exemption for sibling-to-sibling transfers.  Imagine Child A and Child B inherit the family home together.  Child B doesn’t want the house, only cash.  Child A, who wants to remain in the home, takes out a large loan, pays off Child B and deeds Child B off title.  Suddenly, the next tax bill reflects a pulse-skipping new number, because they failed to plan. 

The correct strategy would have been to borrow the loan in the name of the Trust prior to distributions. 

Let’s step back a bit.  In a standard marital “A-B” revocable trust, the terms provide for a bifurcation of three (or more) different trusts when the first spouse passes away.  Without getting into too much detail, nothing really changes in practical matters, until the surviving spouse passes away.  That’s when the marital union dissolves and three trusts become one.  More importantly, it becomes irrevocable.  This means whatever assets were put into the trust and beneficiaries named during the life times of the trust creators cannot be changed. In essence, there are no take-backs or re-do’s – the transfer of assets has been made and do not legally belong to the creators anymore. 

Since the trust is not a real person and only a fictional entity, virtually all lenders won’t touch it with a ten-foot pole.  That entity does not carry a job, or a credit history, and it does not earn a salary or wages.  Most irrevocable trusts also have wording that make it difficult, if not impossible, to foreclose on property.  So any loan would be effectively unsecured. 

By now, you’ve probably guessed that there are exceptions and that there must be some oddball lender and/or investor willing to take on the risk.  Yes, that’s true, for I believe every lender has a price!  In order to borrow through an irrevocable trust, there are two types of loans: business purpose and equity-based.  In either scenario, lenders get paid upfront origination fees (2-3 points) to justify the risk, and charge a moderately high rate, usually 8-9% for a short-term loan, anywhere from 2-12 months.  The critical part of the analysis is to make sure there is an ‘exit strategy’, be it a property sale or a refinance.  Once the trust is funded with the new loan, it can easily distribute equally to the two siblings.  For the new homeowner, they will take 100% title as an individual, subject to the existing mortgage lien, and exempt from property-tax reassessment.  For the other sibling, they will receive cash proceeds originally derived from the trust loan.  Now… they can all live happily ever after.  These deals are highly complex because of the numerous tax and estate planning issues involved.  Not only should you consider consulting a highly experienced mortgage broker, but an estate planning attorney well versed in these types of transactions.