How does one determine the debt owed to a trust if trust money was loaned to buy property?
The question is a bit difficult to grasp so let me give some background first. Let's say person A uses some of his own money and loan's money from person B to buy a house (at an interest rate lower than he would get from the bank). Person A rents out the house to get rent income while slowly repaying the debt. Person B in the meantime passes away and an inheritance amount is allocated to a trust (but I'll refer to it person C for simplicity).
So Person C should get an inheritance from person B (which is no longer), and person A is in debt to person B. Now my questions are the following:
How do you calculate the amount that person A owes to person C (considering rent income was used to pay off debt)?
How does person A go about repaying person C? Should the rent income go to C directly as repayment or should A take out another loan to pay off the debt to C first?
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You read. The loan agreement. Then you use basic financial math to calcualate a repayment schedule for the loan for the given interest rate and apply the done payments to it.
That rental income was used to repay the loan is a totally irrelevant fact. It is like any other longer term loan ever given from a bank - there is a repayment schedule and you apply the payments done to it.
How does person A go about repaying person C?
The way that was postulated in the loan agreement.
Should the rent income go to C directly as repayment or should A
So there are no running costs and repairs to be handled from the rental? Funny rental that is. I own some and I have to pay costs left and right all the time. So, no - you go on paying as per agreement.
or should A take out another loan to pay off the debt to C first?
Given that the loan was CHEAP that would put a into the idiot category? Pay of a loan with another loan that has a higher interest rate. Why should he, unless there is a legal requirement to repay as fast as possible. Stick to the original agreement.
(This is from a UK perspective, and with the usual caveat that I am not lawyer but I have been the executor of a couple of wills. Other common law jurisdictions are likely to follow similar principles)
FOUR ACTORS NOT THREE
We need to distinguish 4 actors, not 3:
A - Borrower
B - Lender, who has died
C - Trustees of the estate, created on B's death
D - Beneficiaries of the the estate
Even if C and D are the same actual humans they are legally distinct. C does not get an inheritance - they administer the estate. D receives any inheritance.
NO NEW OBLIGATION ON A
The basic principle is that B's death cannot impose a new obligation on A. It only affects A's obligations if there were terms in the loan agreement covering the event of B's death. If there were express terms for this eventuality they would also define the amount to be repaid.
Assuming there are no such terms in A's loan agreement, A is perfectly entitled to keep paying the loan repayments for however many years the agreement is for.
There is no need therefore for A to make a valuation of the the loan payments or rental income.
The trustees C will have opened a new bank account to keep the estate's assets separate from their own, and A will be given the new banking details to make the payments to the estate.
SETTLEMENT VALUE OF THE LOAN
There might be a mutually acceptable price at which A and C would agree to settle the loan now - but that is simply a matter of negotiation.
The low interest means that the value of the loan to the estate is lower than its headline value. For example if the loan is £!00,000 at 4% for 10 years, fixed monthly payments would be c £1,009. If the market rate was 8% the fixed monthly payment on a loan of £100,000 would be c. £1,199.
At 8% for 10 years, monthly payments of £1,009 correspond to a loan amount of £84,183 so C might reasonably settle the loan for a payment of c £84k.
If the value to C of cash now is greater than the cost of new borrowing is to A then there should be a range of values at which both are happy to settle the loan now. If not then not.
VALUATION FOR INHERITANCE TAX
C will need to value the future income stream from the loan for inheritance tax purposes, and can't distribute anything to D until the tax is paid (if the rental income is large and comprises a large proportion of the estate it may be possible to pay in installments but the rules are complicated)
The valuation method needs to be acceptable to HMRC - probably a net present value conceptually similar to the one above - with (no doubt) some question over the discount rate. (If the loan is settled with A for cash, the value is simply the cash received).
GET ADVICE
For C all this is sufficiently complex that they should get legal & tax advice on what is presumably a substantial amount of money.
Based on what you have written, A didn’t borrow money from the trust (C), so A doesn’t owe C anything. Whether the debt A owes B is assignable from B’s estate to C is a question for your lawyer.
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