Overview

Transferring money or assets to family or friends can be structured as either a lifetime loan or a gift. The decision matters for three reasons: tax rules (gift and estate tax, imputed interest), income-tax consequences (forgiveness or cancellation of debt), and family-law or fiduciary risks (disputes when there’s no clear paperwork). This article explains how each option works, practical pros and cons, tax mechanics, documentation steps, and professional planning tips.

How lifetime loans and gifts actually differ

  • Lifetime loan: You lend money with an expectation of repayment. Good documentation includes a promissory note, repayment schedule, and an interest rate. If the rate is below the IRS Applicable Federal Rate (AFR), the IRS can impute interest and treat the foregone interest as a gift (see IRS AFR guidance) (IRS: Applicable Federal Rates).
  • Gift: A transfer without expectation of repayment. The donor may need to file Form 709 (United States Gift (and Generation-Skipping Transfer) Tax Return) if gifts to a single individual exceed the annual exclusion for the year (see IRS: About Form 709).

Both strategies transfer wealth, but they differ in control, tax reporting responsibility, and how they affect the donor’s estate.

Sources: IRS pages on gift tax and Form 709 (about Form 709: https://www.irs.gov/forms-pubs/about-form-709; gift tax overview: https://www.irs.gov/businesses/small-businesses-self-employed/gift-tax). For AFR: https://www.irs.gov/interest-rates

Pros and cons — quick comparison

  • Control

  • Loan: Donor retains legal claim and usually more control (collateral, enforceable repayment). Preferred when you want to help without permanently reducing estate value.

  • Gift: Donor loses control. Use when you want to remove assets from your estate immediately.

  • Tax and estate impact

  • Loan: Properly documented and repaid loans generally don’t trigger gift tax or reduce estate value. Forgiveness of a loan, however, is treated as a gift (tax consequences below).

  • Gift: Removes the asset from your estate for estate-tax purposes (if beyond exemptions), potentially lowering estate tax liability in large estates.

  • Family dynamics and risk

  • Loan: Can create awkwardness or strain if the borrower misses payments; documentation helps avoid disputes.

  • Gift: Fewer financial expectations, but may create perceived favoritism among heirs.

  • Administrative burden

  • Loan: Requires more documentation and possibly reporting if below-market interest rates are used.

  • Gift: Often simpler for smaller amounts, but requires Form 709 filing if above the annual exclusion.

Tax mechanics to understand (plain-language)

  1. Annual gift tax exclusion and Form 709
  • The federal tax code lets you give a certain amount to each person each year without needing to file Form 709 or tapping your lifetime estate-and-gift exemption. If you exceed the annual exclusion for a recipient in a year, you must file Form 709. Filing doesn’t always mean you owe gift tax—excess gifts generally reduce your lifetime exemption first. The donor, not the recipient, is generally responsible for any gift tax due (IRS: About Form 709).
  1. Lifetime estate-and-gift exemption
  • Large cumulative gifts above the annual exclusions reduce the lifetime estate-and-gift exemption. Exact exemption amounts are adjusted periodically; check the IRS or a tax advisor for the current figure before making large transfers.
  1. Imputed interest and the Applicable Federal Rate (AFR)
  • If you make an interest-free or below-market loan, the IRS may treat the forgone interest as a gift equal to the difference between the AFR and the actual interest charged. To avoid imputed interest causing unexpected gift-tax filings, document the loan and consider charging at least the AFR (IRS: Applicable Federal Rates).
  1. Loan forgiveness vs. cancellation of debt
  • If you forgive a loan, the forgiven amount is typically treated as a gift to the borrower. That gift may require filing Form 709 if it exceeds the annual exclusion. Separately, cancelled debt can sometimes create taxable cancellation-of-debt (COD) income for the borrower—however, when the forgiveness is a gift, that transaction is usually not treated as taxable income to the borrower, because gifts are excluded from gross income (IRS guidance). Documenting intent and timing is important; tax advisors can help align the reporting.
  1. Income-tax basis and capital gains consequences
  • When you gift appreciated property (stock, real estate), the recipient generally gets your cost basis (carryover basis) for purposes of later capital gains tax. That can produce unexpected capital gains tax for the recipient when they sell. See our related primer on tax rules for gifting and cost basis tracking for more detail: “Tax Rules for Gifting and Cost Basis Tracking” (https://finhelp.io/glossary/tax-rules-for-gifting-and-cost-basis-tracking/).

Practical steps to reduce risk

  1. Decide your primary goal: control, tax efficiency, or family harmony.
  2. Document loans with a promissory note that includes: principal, interest rate, payment schedule, collateral (if any), default remedies, and signatures. Treat the borrower as a bona fide debtor.
  3. Use market or AFR-based interest rates for intra-family loans to avoid imputed interest.
  4. If you plan to forgive the loan later, document that decision with a written instrument. If forgiveness will be phased, do the paperwork when the forgiveness occurs.
  5. Track gifts and file Form 709 when cumulative gifts to a recipient exceed the annual exclusion in any year.

Example scenarios (realistic illustrations)

  • Home down payment loan: A parent lends $60,000 at the short-term AFR with a 10-year amortization. The loan is fully documented and repaid. Because the rate equals or exceeds the AFR, there’s no imputed gift.

  • Loan turned gift: A parent lent $80,000 to a child and later forgave $50,000. The $50,000 forgiveness is a gift for tax purposes. If it exceeds the annual exclusion for that year, Form 709 must be filed and the forgiven amount reduces the donor’s lifetime exemption (if no gift tax is due immediately).

  • Straight gift of stock: Donating appreciated stock to a child transfers the donor’s basis. If the child later sells the stock, their capital gain will be calculated using the donor’s original cost basis.

When to favor a loan vs. a gift

  • Favor a loan when:

  • You want to retain legal claim or control over the transferred funds.

  • You expect repayment and want to avoid reducing your estate now.

  • You wish to help someone responsibly while setting boundaries.

  • Favor a gift when:

  • You want the transfer to permanently reduce your estate’s size.

  • You do not want repayment or legal enforceability.

  • You’re using annual exclusions or large gifts as a planned estate-reduction strategy (coordinate with your estate plan; see “Lifetime Gifting vs Bequests: Estate Tax and Family Dynamics” for interaction with wills and bequests: https://finhelp.io/glossary/lifetime-gifting-vs-bequests-estate-tax-and-family-dynamics/).

For complex wealth-transfer strategies (layering gifts with trusts or charitable vehicles), compare options in our article “Wealth Transfer Strategies: Gifting vs. Trusts” (https://finhelp.io/glossary/wealth-transfer-strategies-gifting-vs-trusts/).

Common mistakes to avoid

  • No written loan agreement: Oral loans create ambiguity and family conflict.
  • Ignoring AFR rules: Low- or no-interest loans can trigger imputed interest and unexpected gift-tax filings.
  • Forgetting to file Form 709 when required: Filing is a common oversight for donors who make several gifts in a year.
  • Overlooking basis consequences when gifting appreciated assets: The recipient may face a larger capital-gains bill when they sell.

Checklist before you transfer money

  • Have you clarified whether the transfer is a loan or a gift in writing?
  • Did you set an interest rate meeting or exceeding the AFR if you want to avoid imputed interest?
  • Will the transfer exceed the annual gift exclusion to any single recipient this year? If yes, prepare to file Form 709.
  • Have you discussed the transfer with your CPA or estate attorney?

FAQs (brief)

  • Who pays gift tax? The donor generally pays any federal gift tax. The recipient does not report the gift as taxable income (IRS: Gift Tax Overview).
  • Do gifts reduce my lifetime exemption? Yes: gifts above the annual exclusion count against your lifetime estate-and-gift exemption.
  • Is forgiving a family loan taxable income to the borrower? Generally a forgiven loan is treated as a gift (not taxable income to the borrower), but documentation and timing matter. Consult a tax advisor.

Final planning tips and next steps

  • Keep clear records. Good recordkeeping—signed promissory notes, bank transfers, and written gift declarations—protects you and your family.
  • Coordinate gifts and loans with your overall estate plan. A small gift strategy can preserve liquidity while larger transfers may be better handled through trusts or sale arrangements.
  • Consult a CPA or estate attorney before making large loans or gifts. Tax rules and AFRs change; current guidance from the IRS and your advisor will keep your plan aligned with the law.

Helpful authoritative resources

Professional disclaimer: This article is for educational purposes only and does not constitute legal, tax, or financial advice. Consult your CPA, tax attorney, or fiduciary for recommendations tailored to your situation.