Intra-Family Loans: Real Debt or Gift?

Loans among family members, especially from parents to children, have recently become a more popular estate planning strategy due to the current low interest rate environment, which makes intra-family loans a valuable tool for both lenders and borrowers. Lenders won’t have large amounts of taxable interest income to report, and borrowers may have lower interest rates under the Applicable Federal Rates, as explained below. While intra-family loans are indeed important tools in the broad array of estate planning strategies available to families to transfer wealth to the next generation, most clients are not aware of the tax implications surrounding such loans. It is important that clients understand that charging an adequate interest rate is only one of the many factors that determine whether an intra-family loan will be respected as a bona fide debt. The Internal Revenue Service (“IRS”) may re-characterize an intra-family loan as a disguised gift subject to gift taxation if the form and/or substance of such loan is not respected.