Overview

Intra-family loans are written loans between relatives—commonly parents to adult children or grandparents to grandchildren—used to transfer funds while preserving family control and minimizing tax friction. When structured correctly, they let a family member access capital at below-market terms, shift appreciation, or facilitate investments (like a business or home purchase) without an outright gift. Properly documented loans follow IRS rules (especially the Applicable Federal Rates, or AFRs) and are treated for tax purposes as loans rather than gifts.

Author note: In my 15+ years advising families on wealth transfer, the most successful intra-family loan arrangements use written promissory notes, realistic repayment terms, and regular accounting to avoid surprises and preserve family relationships.

Sources: See the IRS AFR guidance for current interest rates (IRS, Interest Rates) and general consumer guidance about lending and family finances from Consumer Financial Protection Bureau resources.

Why families use intra-family loans

  • Tax efficiency: If you charge at least the AFR and follow loan formalities, the IRS is less likely to treat the transfer as a gift. That preserves gift-tax annual exclusions and lifetime exemption planning.
  • Lower borrowing costs: Borrowers often receive interest rates and terms more favorable than market lenders, helping them buy homes, start businesses, or refinance higher-rate debt.
  • Control: Unlike an outright gift, a loan preserves the lender’s legal claim to repayment and allows structured repayment schedules and collateral if desired.
  • Shift future appreciation: Lending the principal rather than gifting an appreciating asset can shift the future appreciation (growth) to the borrower.

How intra-family loans work (step-by-step)

  1. Decide the loan purpose and amount. Be specific—home down payment, business seed capital, tuition top-up, etc.
  2. Check the IRS Applicable Federal Rate (AFR) for the appropriate term (short-, mid-, long-term) and use that as the minimum interest rate. The IRS posts monthly AFRs: https://www.irs.gov/interest-rates (IRS).
  3. Draft a promissory note. Typical elements:
  • Principal amount and disbursement date
  • Interest rate (fixed or variable) and method of calculation
  • Repayment schedule (dates, amounts, amortization or interest-only)
  • Term or maturity date and prepayment terms
  • Default remedies and any collateral/security
  • Governing law and signatures of lender and borrower
  1. Make and record payments. Treat the loan like any outside lender: send invoices or payment reminders, and keep bank records to prove regular payments.
  2. Report interest income. Interest received by the lender is taxable income and should be reported on the lender’s tax return unless excluded by specific rules.
  3. Revisit the arrangement before major life events (refinancing, death, gift intention) and consult tax and estate counsel.

Practical note: Courts and the IRS consider substance over form. If the borrower never makes payments, the lender forgives the debt, or the interest rate is artificially low, the transaction may be recharacterized as a gift.

Documentation and drafting tips (what I use in practice)

  • Use a written promissory note drafted or reviewed by a lawyer. Generic templates can help start the conversation but customize terms to family needs.
  • Use a market-based interest rate—at least the AFR for the loan term—to prevent imputed interest or deemed gifts.
  • Require regular payments, even token principal payments, to demonstrate intent to repay.
  • Consider collateral for very large loans. Securing the loan with an asset (e.g., the home) clarifies the lender’s expectation of repayment.
  • Maintain a payment log and deposit interest receipts into the lender’s account to document taxable income.

Checklist for the promissory note

  • Lender and borrower legal names
  • Clear definition of principal and disbursement date
  • Interest rate, calculation method, and compounding
  • Payment schedule and maturity date
  • Prepayment penalties or rights
  • Default definition and remedies
  • Signatures and notarization if desired

Tax and reporting considerations

  • AFR and imputed interest: The IRS publishes AFRs that are the minimum interest rates for tax-favored intra-family loans. Charging below-AFR rates may trigger imputed interest rules under Sections 1274/7872 of the Internal Revenue Code, creating taxable interest income to the lender and a gift to the borrower (IRS, Interest Rates).

  • Gift tax issues: If a loan has below-market terms or is later forgiven, the difference can be treated as a taxable gift and may require filing Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. Always check the current annual gift-tax exclusion and lifetime exemption amounts on IRS.gov before relying on gifting strategies.

  • Income tax: Interest paid by the borrower is generally taxable to the lender. For large loans, ensure the lender reports interest income on Form 1040 (or on other applicable forms) as required.

  • Estate planning: An outstanding promissory note is generally an asset of the lender’s estate at death. If your estate plan assumes loans reduce estate value, coordinate with your estate attorney because the IRS may scrutinize terms and valuations.

Author’s practice tip: I always recommend clients run scenarios with their CPA to model (1) imputed interest if AFR is not applied, (2) income-tax consequences of interest received, and (3) estate-tax treatment if the lender dies with outstanding balances.

Real-world examples and use cases

1) Home purchase down payment: A parent loans $100,000 to an adult child for a down payment, charges AFR-based interest over 15 years, takes a security interest in the home if needed, and records monthly payments. The child benefits from lower closing costs and lower rate than some marketplace lenders.

2) Small business seed capital: A grandparent lends capital to a startup operated by a grandchild. With a documented term and realistic interest, the family can access growth opportunities that external lenders might decline.

3) Interest-rate arbitrage for estate planning: A lender with a large taxable portfolio loans cash to a lower-income child. If the child invests the funds and earns a higher return than the AFR, the family can effectively move investment returns to the child’s lower tax bracket.

Cautionary tale from practice: I advised a family where an undocumented transfer was treated as a gift by the IRS. The parents intended a loan, but no promissory note or documentation existed, and no payments were made—leading to gift-tax exposure and family conflict.

Common mistakes and how to avoid them

  • Treating a loan as informal: Always use a written agreement.
  • Charging no interest or below-AFR rates: This invites imputed interest and gift treatment.
  • Lacking evidence of repayment: Keep bank records and ledgers showing payments.
  • Forgiving the loan arbitrarily: Partial or full forgiveness can create taxable gifts—plan transfers deliberately, perhaps using annual exclusions.

Further reading on gift-tax mechanics: How the Federal Gift Tax Exclusion Works (FinHelp) and Lifetime Loans vs Gifts: Pros, Cons, and Taxes (FinHelp).

Practical structuring ideas

  • Hybrid loan/gift: Make part of the funding a loan and part a gift within the annual exclusion—document both parts separately. This is a common way to gradually transfer wealth.
  • Graduated or income-driven payments: If the borrower expects variable cash flow (e.g., new business), use income-sensitive repayment terms with a floor interest rate at or above the AFR.
  • Use for rate arbitrage: If the borrower is in a lower tax bracket and can invest proceeds at a higher pre-tax return than the AFR, the family benefits collectively.

What to discuss with your advisors

  • CPA: Model income-tax and imputed interest effects.
  • Estate attorney: Ensure the loan fits into the estate plan and discuss whether to secure the loan and how it affects probate and estate valuation.
  • Financial advisor: Run investment-return scenarios to see whether borrowing from family makes financial sense compared with market options.

FAQs (short answers)

Q: Does the IRS limit how much I can lend?
A: No statutory dollar cap on loans, but large loans with favorable terms can trigger gift-tax consequences or imputed interest rules.

Q: What if the borrower can’t repay?
A: The lender can renegotiate, pursue collection, or forgive the debt. Forgiveness may be a taxable gift—plan with counsel.

Q: Do I need to file any tax forms?
A: If a loan is forgiven or treated as a gift, Form 709 may be required. Interest received is reportable as taxable income. Check current IRS guidance.

Final recommendations

  1. Use a written promissory note with AFR-based interest.
  2. Keep regular payment records and treat the loan like any market loan.
  3. Consult a CPA and an estate attorney before closing large intra-family loans.
  4. Periodically review the loan terms, especially if circumstances change (refinancing, financial hardship, or donor death).

Professional disclaimer: This article is educational and does not replace personalized legal, tax, or financial advice. For tailored guidance, consult a qualified CPA and estate attorney.

Authoritative resources

  • IRS — Interest Rates (Applicable Federal Rates): https://www.irs.gov/interest-rates
  • Consumer Financial Protection Bureau — Guidance on family lending (see consumerfinance.gov)