With current interest rates at near historic lows, loans among family members, "intrafamily loans," continue to be a popular means of assisting family members and keeping wealth within the family. Such loans can be part of more complex planning, including transfer of family business interests, or a stand-alone way for parents to support children or other family members in financing major purchases by transferring wealth with advantageous interest rates and minimum tax consequences.

A properly structured and managed intrafamily loan has many benefits, including (a) much lower interest rates for the borrower compared to commercial lending rates, (b) no recipient credit checks or reporting, (c) no loan costs to the recipient, and (d) better return rate for the lender than cash sitting in a bank account.

Meeting IRS Requirements

Intrafamily loans are generally scrutinized by the Internal Revenue Service (IRS) to safeguard against family members and related entities making disguised gifts, and therefore must be carefully structured and administered.

When structuring an intrafamily loan, the focus should be on documentation and performance:


Like most other loans, the borrower of an intrafamily loan must have an unconditional obligation to repay the money, and the lender must have an unconditional intent to secure repayment. Intra family loans typically use the lower than commercial lending interest rate called the Applicable Federal Rate (AFR). There are three AFRs:

  • Short-term loans of up to three years;
  • Mid-term loans from three to nine years; and
  • Long-term loans of more than nine years.

The interest rate also depends upon how often interest is compounded under the loan. These interest rates are published by the IRS and are updated monthly. In a typical intrafamily loan, the interest rate for the duration of the loan is fixed at the AFR for the month in which the loan documents are executed.

At a minimum, to avoid gift issues, a promissory note containing unrelated party (arms’ length) loan terms (such as interest and/or principal payment terms, loan duration, security requirements, prepayment penalties (if any), default penalties, etc.), should be used to memorialize the arrangement. Additionally, the lender should consider securing a pledge of collateral from the borrower (such as a deed of trust as to real property or security agreement), or filing a UCC-1 financing statement.

There also must not be any prearranged plan to forgive the loan. Further, interest received by the lender on the loan should be reported on a Form 1099-INT and on the lender’s income tax return, and if the loan qualifies as a mortgage, the interest should be reported to the IRS on a Form 1098.


The IRS presumes that a transfer of money to a family member is a gift unless there is a valid creditor-debtor relationship. Therefore, in addition to documentation, the IRS looks at whether the loan obligation was repaid, and if the lender and borrower observed the formalities of the loan terms and acted as unrelated lender and borrower would.

Beyond Paperwork

Aside from the administrative burden of properly documenting and managing an intrafamily loan, there are other issues to consider when deciding whether an intrafamily loan is a good fit, such as:

  • The interest income is taxable to the lender and not tax deductible to the borrower unless, as to the latter point, the loan qualifies as a mortgage and the payments are within the then current mortgage interest deduction limits.
  • The borrower may be unable or unwilling to pay back the loan, which may cause family discord or result in the loan becoming a taxable gift. If this risk exists, it may make more sense for the parent(s) to make an annual exclusion gift. The current amount that can pass by gift from one person to another person without using any portion of the donor’s lifetime federal gift tax exemption is $15,000. Two parents can give one child $30,000 per year under the annual exclusion. The annual exclusion is indexed for inflation.