I recently worked with a couple who wanted to support their adult child through the process of buying his first home. Though their son had saved for a down payment, the parents felt that the current real estate market and high interest rates would limit his options and saddle him with a burdensome fixed monthly payment.
We talked through several options, including a one-time gift to cover the down payment, a larger gift to allow for a full cash purchase, direct support with monthly payments, joint ownership, and, lastly, utilizing an intrafamily loan. Ultimately, they felt an intrafamily loan was the best fit for their circumstances.
Here's why they chose an intrafamily loan and what topics for you and your advisors to discuss if you’re considering lending or borrowing money within your family.
Family Dynamics
Assisting a family member with a loan can have positive ripple effects on the overall family dynamic. The benefits can set a precedent for open communication about financial matters and encourage a collective responsibility for each other's well-being. In this family’s case, they wanted their son to feel supported in pursuing his career aspirations and living a good life, while still holding him financially responsible for this major purchase. The formalized legal terms of their intrafamily loan helped accomplish exactly those aims—conveying support through a structure that worked for him, with clearly defined terms and rates.
With these benefits in mind, it is important to be transparent with any other siblings. In almost all cases, intrafamily loans are undoubtedly a financial benefit to the recipient. Actual or perceived preferential treatment can lead to unintended consequences. Each family has their own perspective, however exploring options to “true-up,” or make similar loans available to impacted siblings should often be considered.
Flexible Terms
A major reason this family chose to set up an intrafamily loan was due to their son’s profession. As an early-career musician, they were concerned he would face underwriting challenges from traditional lenders. They also valued having flexibility to tailor the repayment schedule in a way that worked for their son and for them.
The flexibility of an intrafamily loan can be one of its most attractive qualities, relieving the burden of traditional loan qualifications, higher required interest rates, and less flexible terms. Family loans can often be made more quickly than a traditional loan that is required to go through a full bank underwriting process, potentially making them a good potential solution in an emergency. The repayment terms can also be structured in unique ways, such as an interest-only period with a balloon payment due later—a potentially attractive option for loaning capital to start a business.
Tax Considerations
There are important income and tax considerations for family loans versus gifts. To avoid the loan being treated as a gift, the IRS requires any intrafamily loan to be formally documented in writing, have a pre-determined fixed repayment schedule, and a minimum interest rate charged. Unless the loan is under $10,000 and the recipient is not using the proceeds for investments (where no interest is required), the minimum interest rate is often the Applicable Federal Rate (AFR), published monthly by the IRS. Should you fail to charge an adequate rate, it is considered a “below-market loan.” In this case the IRS could treat the loan as a gift or lead to unintended tax consequences for both the lender and borrower. Just like any other interest received, the parents in this case will need to report and pay taxes on the interest income. If the loan proceeds were used for their son’s business, he would be able to deduct the interest he pays.
Alternatively, if the money was given outright, or a below market interest rate is charged, the transfer would be treated as a gift. Unless the amount is less than the annual exclusion limit ($18,000 per individual or $36,000 per married couple in 2024), the lender will be responsible for filing a gift tax return and potentially paying gift taxes, depending on their available Lifetime Gift Tax Exemption.
Tax laws can be complex, and you should always consult with a tax professional or financial advisor for personalized advice.
Things to Keep in Mind
If you’re considering an intrafamily loan, here are several factors to consider and steps to take.
- Consider the personal impacts: Assess your own financial situation and determine if you can afford to lend the money without jeopardizing your own financial well-being. Consider the impact on your relationship if the borrower is unable to repay the loan. Money matters can strain relationships, so be prepared for potential challenges.
- Communicate: Clearly communicate the terms of the loan, including the amount, interest rate (if any), and repayment schedule. Ensure both parties have a clear understanding of the expectations and consequences if the terms are not met.
- Ability to repay: Evaluate the borrower's ability to repay the loan. Discuss their financial situation, job stability, and any potential challenges they may face in meeting the repayment terms. Work together to create a written repayment plan that is realistic and considers the borrower's financial situation.
- Put it in writing: It's crucial to document the loan agreement in writing. This can help prevent misunderstandings and protect both parties in case of disputes. Work with a lawyer to structure a clear and legally sound agreement.
- Know the tax implications: Be aware of the legal and tax implications of charging interest (or not) on the loan. Consult with a legal professional to ensure compliance with local laws.
- Consider alternatives: If you're uncomfortable with the idea of lending money, consider other ways to offer support, such as co-signing a loan, providing a one-time gift, or helping them explore other financial options.
Remember that every family dynamic is different, and what works for one may not work for another. That said, intra-family loans can be a win-win solution, offering families the ability to share wealth amongst generations. Before finalizing the loan, consider seeking advice from your financial or legal advisor to ensure that you are making a well-informed decision.
The opinions and analyses expressed in this newsletter are based on Curi RMB Capital, LLC’s (“Curi RMB”) research and professional experience are expressed as of the date of our mailing of this newsletter. Certain information expressed represents an assessment at a specific point in time and is not intended to be a forecast or guarantee of future results, nor is it intended to speak to any future time periods. Curi RMB makes no warranty or representation, express or implied, nor does Curi RMB accept any liability, with respect to the information and data set forth herein, and Curi RMB specifically disclaims any duty to update any of the information and data contained in this newsletter. The information and data in this newsletter does not constitute legal, tax, accounting, investment or other professional advice. Returns are presented net of fees. An investment cannot be made directly in an index. The index data assumes reinvestment of all income and does not bear fees, taxes, or transaction costs. The investment strategy and types of securities held by the comparison index may be substantially different from the investment strategy and types of securities held by your account. RMB Asset Management is a division of Curi RMB Capital.
The content contained herein was generated by RMB with the assistance of an AI-based system to augment the effort.
Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.
