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My wife's father died last year and left a decent sized inheritance to my wife and her two brothers. The estate is complex and includes multiple IRAs and two trust funds, so settling the estate has taken longer than expected. The three parties have already received about 1/3 of the inheritance, which we (my wife and I) elected to take in kind and place in an IRA so as not to liquidate the equities in a down market.

One of her brothers entered into a contract to buy a house based on the assumption he would have his share of the full inheritance by now, which turned out to be a bad assumption. This brother approached us and the other sibling and asked us to advance him $50K now and reduce his remaining share of the inheritance by the same amount.

Although we're willing to do this, we're not willing to give him a free loan. To give him $50K we will have to liquidate equities, which means realizing an immediate loss and also taking that money out of the investment pool for future gains. So I'm trying to figure out the fairest way to structure this loan.

My first thought was something like this:

He repays us the sum of:

  1. The original principal ($25K each).
  2. The loss we actually realized when we liquidate the equities.
  3. Any gains we would have realized between the time we made the loan and he repays it, or 5% simple interest, whichever is greater.

But I can see several flaws in this. For example, if the equities improve substantially, we will lose future earnings on those equities because we will have to buy them back at a higher price and thus own fewer shares. And clearly there will be tax consequences of the distribution from an IRA, so not sure how to account for that.

Is there a better way to structure this that's fair to all but in particular protects us? Needless to say we'll be having an attorney draft the agreement, but I want to get an idea how to instruct the attorney to proceed.

Also, are there more risks I'm not seeing here?

EDIT: A discussion with our financial advisor resulted in exactly the same advice I've gotten here, although he was more succinct. He said, "Yes, it can be done, but you'd be crazy to do it. Let him go get his own loan." So we will not be proceeding with this idea.

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    This isnt an answer so I wont post it as one. But just say no, unless you are willing to sue him for the money, do not loan it to him. This generally procludes significant financial deals with friends or family. – Vality Jun 11 at 19:11
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    Also not an answer, but consider having him approach a bank for a loan, on the basis of his incoming inheritance. If a bank won't do it because receiving the inheritance seems shaky to them; well, that says something about whether you would want to do it, either. – Grade 'Eh' Bacon Jun 11 at 19:16
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    IRAs generally pass to the IRA beneficiaries outside the estate (not for estate tax purposes but as far as involvement by the executor is concerned), unless, of course, no beneficiary was designated by your father-in-law in which case the estate was the beneficiary by default. If the IRA listed the siblings as beneficiaries, then the IRA custodian would create Inherited IRAs for each and not "elected to receive in kind and place in an IRA". – Dilip Sarwate Jun 11 at 19:22
  • @DilipSarwate I'm not sure I understand your comment. My wife is the executor, but she has attorneys and a financial advisor handling the details so I'm confident it's being done right. Apologies if I used inaccurate language. – Carey Gregory Jun 11 at 19:38
  • This is NOT a question for the internet. There are too many potential tax ramifications for someone not specifically familiar with everything involved to successfully answer. There can be taxes created on loans to relatives as the wealthy have used those as tax shelters in the past and Congress regulates it. This is a question for a local CPA and local attorney. Depending on the language of the will and trusts, it may be possible for the estate to issue the loan. A better solution is to inquire as to the delays and get a likely funding schedule. – Dave Harris Jun 11 at 20:54
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Structuring a loan to someone based on market performance is a Pandora's Box. Or perhaps it's as Forrest Gump said: "Life is like a box of chocolates. You never know what you're gonna get." Some random thoughts...

Why should your brother have to indemnify you for realized losses if you sell your underwater securities? The loss already exists and that's not his responsibility nor did he cause it.

Up to $3k per year of such losses are deductible each year unless you have already maxed out your deduction so you will benefit by paying less taxes, either now or later. In all fairness, are you willing to reimburse him the annual amount of your tax savings?

You want your brother to indemnify you for opportunity loss on your future gains should the equities appreciate after you sell them. If the market tanks, are you willing to indemnify him for the amount that he saved you because of security liquidation before the securities dropped in value?

If he indeed indemnifies you for upside opportunity losses missed, you are in the same position as you were before. For example, sell 200 shares at $25 ($5k). When he's ready to pay you back, they are $30 ($6k). For that security, he gives you $1k and you now have your 200 shares back with a tax cost basis of $30 that really only cost you $25. You're better off because with your higher purchase price, you'll pay less taxes upon sale. Plus, he indemnified you for your losses (see above) so you're dunning him twice. You have lost no future earnings on those equities and you own will not own own fewer shares. As an aside, who in their right mind would agree to a loan with no cap? Suppose those shares tripled to $75 due to M&A. He now owes you $10k to make you whole on this component of the loan ???

The permutations of this can be endless and convoluted. It's just a bad idea with no good solution.

Your brother should apply for a loan to tide him over. If that's not possible, keep it simple and take out the loan yourself and collateralize it with a lien or legal contract against the pending assets that he is to inherit. Let your attorney find a fool proof solution instead of a foolish, well meaning assist that is fraught with complications.

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    "The loss already exists and that's not his responsibility nor did he cause it." -- The loss exists only on paper and I fully expect those securities will recover if not liquidated. Selling them now would realize a loss we otherwise probably would have avoided. – Carey Gregory Jun 11 at 20:05
  • It's an assumption on your part that present losses will be avoided because of future gains. And despite that, it's not relevant to overall premise. You want reimbursement for losses that you benefit from. You want reimbursement for gains you may miss. You get the tax benefit of those losses. You might even benefit if the market tanks after you sell the securities. Does you brother get to only pay back 1/2 the loan if the securities drop 50% in value after you sell them?? (see 2000 or 2008). It may seem clever but it's a bad plan. – Bob Baerker Jun 11 at 20:15
  • Well, my question is how to structure it fairly. – Carey Gregory Jun 11 at 20:51
  • You can't structure it fairly. What you want is an investment in stocks, what he wants is a simple loan. You want to transfer the risk while keeping the benefits. That's all besides the point that it all is a terrible idea in the first place. – xyious Jun 12 at 17:56
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One option would be a pledged asset line of credit -- basically you take out a line of credit or loan that is backed by the securities you have invested. Many/most investment firms will offer a product like that.

This way you don't have to liquidate any securities and incur capital gains, and you can work out a loan with your family member where his interest rate to you tracks the line of credit you have on the pledged asset line. I'm not sure on the tax implications since you will have interest income from your brother in law, so be aware there may be some subtleties.

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