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When interest rates are low, intrafamily loans can be a good way to assist a relative (typically a child) with purchasing a house or a family business, and in certain circumstances they can be used to gift money to the next generation.
An intrafamily loan allows family members to borrow money from each other at a special rate, but it must be structured properly so that the loan is not considered a gift. This means the loan must have a written promissory note, require repayment, and charge interest (if the loan is for more than $10,000). The IRS sets the Applicable Federal Rate (AFR) each month, and the interest on the intrafamily loan must equal the AFR. The rate is different, depending on the term of the loan, which can be a short-term loan (0-3 years), a mid-term loan (3-9 years), or a long-term loan (9 or more years). The AFR is typically lower than the interest rate a bank would charge, and the borrower’s credit doesn’t affect the loan, so someone with bad credit can still get a loan.
When structured properly, intrafamily loans can assist children with purchases and pass on assets. The following are some of the ways intrafamily loans can be used:
The downside of an intrafamily loan is the same as with any loan: The loan must be repaid. If the child defaults on the loan, it could trigger a gift tax for the person making the loan. It is also important to have the correct paperwork and documentation. Intrafamily loans should only be set up in consultation with your attorney. To find an attorney near you, click here.