When You a Lender Be

On Behalf of | Aug 10, 2022 | estate and tax planning, Estate Planning

Shakespeare’s Hamlet was famously advised “Neither a borrower not a lender be, for loan oft loses both itself and friend.” Jeff Simpson seems to agree, pointing out in Financial Advisor Magazine that “giving money to friends and family can involve gifts or loans that can carry emotional baggage and ignite tax concerns,” Despite those risks, intra-family loans can often play a useful part in estate and gift planning, as we explain to clients of Geyer Law..

“Before you flip out your checkbook, it may be wise to examine some of the considerations of family loans and the potential consequences, Brian O’Connell writes in Investopedia. O’Connell has a few pieces of practical advice, including treating loans as a business deal, openly communicating repayment expectations, and never keeping loans secret from your spouse.

On the positive side, as ElderLawAnswers points out, intrafamily loans can be a good way to:

  1. assist a child with purchasing a home or business
  2. gift money to the next generation

Rules that must be followed include:

  1.  having a written promissory note
  2. charging interest at the Applicable Federal Rate set out monthly by the IRS

Debts do not die when either the lender nor the borrower dies. If a parent has lent money to a child and dies before the loan is paid off, the borrow must repay the loan to the parent’s estate. On the other hand, an intrafamily loan can be structured to provide that the loan is to be forgiven upon the death of the lender. (Borrowers who are beneficiaries of the estate will have the outstanding loan balance deducted from their share.).

“In these uncertain times, intra-family loans have become a more competitive option than commercial loans, Brian Roth of nixonpeabody.com points out. With intrafamily loans:

1. Closing costs are minimized
2. The terms can be structured more flexibly than commercial loans
3. If the younger generation borrower can earn a greater return using the money than the AFR rate they pay the parent or grandparent, they can keep that extra return without having any gift tax consequences.
4. Parents and grandparents can use their annual gift tax exemption to forgive part or all of the principal of the loan.

In working with our clients at Geyer Law, we are sensitive to the fact that when family members become family lenders, the transactions are inextricably related to intrafamily dynamics.