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Intrafamily Loans: Keeping it in the Family

In” Intrafamily Loans: The Good, the Bad and the Ugly,” Kiplinger.com offers advice on sensible ways to loan money to family members. These are loans for significant amounts with payment plans and interest. The article notes that because the gift tax exemption as now increased to $11.58 million for an individual and $23.16 million for a couple, this has eliminated the need for intrafamily loans for many people. There are still instances, however, when people still make intrafamily loans.

When loaning money to family members, people usually use the Applicable Federal Rate (AFR). This is the lowest interest rate possible so the loan is not considered a gift. If the interest rate is lower than the AFR, then the IRS considers it to be a gift.  (You can view current AFR rates here: https://apps.irs.gov/app/picklist/list/federalrates.html.)

You may wonder why someone would go to the trouble of setting up a formal loan with a family member. One reason is that these loans can be made to people with low credit scores and there is no need for underwriting. In some cases, an intrafamily loan is used so a child or grandchild can purchase a home.

Another, very important reason is to transfer shares of a business. It might seem easier to just  give the child or grandchild the business but:  “If the business is simply gifted to the next generation, all income from the business is passed downstream as well; however, if a note is taken back by the selling generation, then annual note payments will provide parents with a nice income stream.”

The article warns there are situations where this can backfire. If there is resentment because one child gets a loan in the first place, a bigger loan, or a number of loans, it might not be worth it. And if the payback of the loans is based on the profit of a business and the business is not longer profitable, this can be an issue. It is possible to start to incur gift tax when payments are no longer made on the loan.

A Fee-Only financial advisor can talk with about whether an intrafamily loan will be beneficial in your situation.