Intra-Family Loans

Family signing loan docs

Lonnie A. Whitehead, CFP®
Senior Wealth Planning Strategist
Comerica Wealth Management

Key Takeaways:
  • Intra-family loans are flexible planning tools with favorable interest rates
  • These loans can be utilized in different ways to achieve various goals
  • Proper consideration should be taken to ensure the appropriateness and feasibility of utilizing an intra-family loan

There are several estate and financial planning strategies that wealthy families utilize to transfer wealth, and ensure their wishes are carried out upon their passing. One of these popular strategies is intra-family loan. Intra-family loan, as the name indicates, typically loan between family members. These loans provide an effective and efficient source of capital for the borrower, while potentially providing estate planning benefits to the lender.

Intra-family loans are typically loans between family members. These loans provide an effective and efficient source of capital for the borrower, while potentially providing estate planning benefits to the lender.

While most traditional loans assess interest rates based on established benchmarks, such as the 10-year treasury note, intra-family loans utilize the Applicable Federal Rate, often referred to as the “AFR. AFR varies slightly based on the length of the promissory note, with short-term applying to note ranging up to three years, mid-term applying to notes ranging from three to nine years and long-term applying to notes 10 years or longer. The AFR is established monthly by the IRS and is lower than the rates on other sources of capital. For example, the posted AFRs for October 2022 were 3.40% for short-term, 3.28% for mid-term and 3.43% for long-term loans1. Compared to the average 30-year fixed mortgage rate of 7.17% as of October 14th, 2022, the AFR allows you to provide loans to other family members at favorable rates2. Also, October 2022 mid-term AFR is currently lower than both the short-term and the long-term AFR, those that may already have an intra-family loan in place that is scheduled to mature in the next few years may want to explore “refinancing” options for the loan. This will allow you to potentially extend the length of the loan term to better fit with your overall plan.

While lower rates are an attractive loans, there are several other benefits to be found. Intra-family loans are flexible and can be structured as interest-only or amortized. Should rates fall in the future or if the payment structure needs to be modified for any reason, these loans can be restructured or renegotiated.

Businessowner families frequently use intra-family loans as a strategy for their children or other family members to have "skin in the game" so to speak, rather than simply gifting ownership in the business to them. These loans are also used in coordinate with estate and wealth transfer planning techniques.

When structured properly, you could potentially shift the future appreciation of an asset out of your estate, while also providing the flexibility to utilize your gift and estate tax exemption to forgive repayment of the note at some point in the future, if desired. These loans can even be structured as a Self-Cancelling Installment Note (SCIN), allowing for the note to be forgiven at a future date or event, without the remaining unpaid note balance being included in your taxable estate. Careful drafting of the note should be taken by an attorney to ensure the appropriate rate and language is incorporated. It is imperative that you work with your advisors and an estate planning attorney who is well[1]versed in SCINs to discuss the appropriateness of this technique.

We've discussed the basics and benefits of intra-family loans, but how are they used day to day? Let's review a few circumstances where an intra-family loan may be incorporated.

For families with the liquidity to do so, intra-family loans can provide children and other family members the necessary capital to participate in investment opportunities they may be unable to otherwise.

Many business owners are looking for effective strategies to transfer ownership of their company to the next generation. The simplest method is to gift interests or shares of the business. While this is a straightforward approach, there are a few downsides.

First, the IRS places limitations on the amount that can be gifted without a tax being applied in the form of the lifetime gift tax exemption (currently $12,060,000 per individual in 2022). Second, many business owners want to realize the liquidity associated with those shares. A gift would not accomplish the goal of providing liquidity to the business owner. Third, a gift of interests or shares to a family member may not provide incentive for those business owners that want the recipient to earn or work for their share.

By utilizing an intra-family loan in conjunction with the transition of the company, the business owner could potentially sell their shares or interest to a child or family member in exchange for a note receivable. This gives the child or family member skin in the game, and provides liquidity to the business owner for their interest they will no longer own.

For families with the liquidity to do so, intra-family loans can provide children and other family members the necessary capital to participate in investment opportunities they may be unable to otherwise, to purchase a home at a favorable interest rate, and on some occasions, pay down their high interest debt in exchange for a flexible intra-family loan at a lower rate.

The benefits and potential uses of intra-family loan are very attractive, but these loans are not without their potential pitfalls. Unless structured as a SCIN, the balance of any outstanding intra-family loans would be included in your estate upon your passing. Depending on the size of your estate and the gift and estate tax exemptions at that time, the note balances could cause the estate to be taxable. The specific dynamics of your family construct is another consideration that should be taken. Providing an intra-family loan to one child versus another may cause strife or discord amongst siblings. Also, if in any given year you choose to forgive the loan payments, potential gifting implications must be addressed.

Intra-family loans are a planning tool for families. They can provide opportunities that may not be available otherwise, can encourage financial responsibility and can serve as an efficient estate and wealth transfer planning tool to potentially reduce future estate taxes. These loans are not a not a one-size-fits-all strategy, so proper planning should be done to analyze the appropriateness and feasibility in your specific situation.

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1 Internal Revenue Service Applicable Federal Rates (https://www.irs.gov/pub/irs-drop/rr-22-18.pdf)

2 “Today’s 30 Year Mortgage Rates – October 14, 2022 (https://www.bankrate.com/mortgages/30-year-mortgage-rates/)

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