All About Intrafamily Loans

An intrafamily loan is a financial agreement between a family member who borrows money from a lending family member. These loans benefit children and grandchildren learning to be financially responsible but may have difficulty obtaining a loan due to age or credit score. In many circumstances, these loans offer flexible repayment terms and interest rates. Some common uses for intrafamily loans include:

  • Home purchase
  • College tuition
  • Paying down high-interest debt
  • Funding a business
  • Adding to investment portfolios
intrafamily loan

Opting for an Intrafamily Loan

The method by which you loan or gift money to loved ones has potential tax implications. An intrafamily loan could help pass wealth down generations and reduce estate taxes. Also, unlike a gift, it lets you keep control over the money you lend. Intrafamily loans can help preserve wealth in the following ways:

Estate Tax Planning

If your family member invests the loan and earns more than the interest, they get the extra money tax-free. Following loan rules preserves your estate tax exemption. This strategy preserves your lifetime estate tax exemption amount. However, the growth in the investment will not be included in your taxable estate. It’s also worth considering loaning money to a trust rather than directly to a family member. If the investment returns from the loan are higher than the loan’s interest rate, the extra money is a tax-free transfer to the trust.

Flexible Interest Rates

Intrafamily loans allow you to set a lower interest rate than commercial lenders. Therefore, the borrower can save a lot of money. Moreover, if the AFR is high when you start the loan, it might be easier to adjust it later to benefit from lower rates than the borrower needing to refinance with a third-party lender.

Family Business Succession

Intrafamily loans can help the transfer of a family business. By lending money to family members who want to run the company, you can make the transition easier and keep the family legacy going.

Important Considerations

The IRS considers money transfers between family members as gifts unless otherwise specified. For this reason, it’s crucial to sign a comprehensive promissory note to document the loan transaction correctly. This documentation also helps families steer clear of potential misunderstandings between members. When determining if this type of loan is best for your family, consider the following:

  • Is lending to one child unfair to the others?
  • Should other loan types be considered?
  • Could a loan default create tension within the family?
  • Will the loan be forgiven, or will it remain a debt owed to the estate?

Loans VS. Gifts

Consider income, estate, and gift taxes when deciding whether to create a loan or provide a gift. Intrafamily loan tax rules are complex, and mistakes can lead to problems. If you already have a family loan, document it in your estate plan to avoid issues if you pass away before the borrower repays it. Contact us today to learn more about intrafamily loans and how they may affect your estate. Our tax planning attorney is here to help you decide if this strategy best fits your family’s needs.