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Volume XIII, Number 158


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Intrafamily Loans

Many clients use intrafamily loans to assist a relative with the purchase of a residence, the funding of a business venture or an investment in any other asset. If properly structured, intrafamily loans also provide clients with an excellent tax planning strategy. To avoid having any part of an intrafamily loan considered a gift for tax purposes, a client should follow specific guidelines, including charging a minimum interest rate, documenting the loan, and requiring payment under the loan terms.

The Applicable Federal Rate.  

An important rule is that the loan must bear interest at a rate equal to or greater than the Applicable Federal Rate (“AFR”). The AFR for each month—which is published by the IRS on or around the 20th day of the preceding month—is broken into three tiers depending on the term of the loan: the short-term rate applies to loans of up to three years, the mid-term rate applies to loans with a term between three and nine years, and the long-term rate applies to loans with repayment terms of greater than nine years.

The rates for August 2020, which are historically low, are:

Short-Term – 0.17%

Mid-Term – 0.41%

Long-Term – 1.12%

The current AFR makes intrafamily loans an especially attractive estate planning vehicle. 

Repayment Structure.  

It is important that the terms of the loan be followed.  The loans may be structured in a variety of ways. Clients will often select one of the following three types of payment terms:

            Interest Only Payments.  Under this arrangement, the borrower pays interest on an annual basis to the lender and makes a balloon payment of principal at the end of the payment term.

            Amortized Payments. The borrower pays a specific monthly amount designed to pay off the interest and principal amount throughout the term of the loan.

            Accrued Interest.  The interest on the loan is not paid currently, but is instead added to the principal amount due on an annual basis.  All interest and principal is due at the end of the term of the loan.

Generally, the Amortized Payment structure costs the borrower the least amount of interest and the Accrued Interest plan costs the borrower the most amount of interest.  Note that the interest cost difference between each strategy becomes more pronounced as interest rates rise. The selection of which payment structure to use will depend on the overall goal for using the intrafamily loan.


In addition to the payment structure, the client should consider whether to require security for repayment of the note.  For example, when the borrowed funds are being used for the purchase of real estate, there is generally security in the form of a mortgage on the property, which would be beneficial to protect the client’s interest in the note and property from claims of creditors or divorcing spouses of the borrower. The mortgage may also be beneficial if the borrower later attempts to refinance the mortgage through traditional banking methods. A mortgage may also permit the borrower to deduct the interest expense on their personal income tax returns. 

Note Forgiveness.

 In an intrafamily loan, sometimes the Lender will want to forgive a portion of the note from time to time. While this can be an effective strategy, there are important considerations to keep in mind:

Income Tax. When a lender forgives interest on a promissory note, that lender must still recognize the forgone interest as income.

Gift Tax.  To avoid an argument that the entire loan is a taxable gift, the lender must avoid any implication that there was a prearranged agreement to forgive the borrower’s interest or principal payments. This can be done by ensuring that the forgiveness is in the lender’s absolute discretion, and that the note is both subject to seizure by the lender’s creditor’s, and enforceable against the borrower by the lender’s estate if the lender dies during the term of the loan.

Note Refinancing. 

Finally, clients with existing promissory notes may benefit from these record-low interest rates through a note refinance.  If the terms of the original loan permit a prepayment of the promissory note at any time without penalty, then the lender may be able to reissue a replacement promissory note that takes advantage of that lower interest rate.


Intrafamily promissory notes can be an effective tool for transferring wealth to a family member in a tax-efficient manner.  Given the current AFR, it is a good time to consider whether this strategy would be appropriate for you.

© 1998-2023 Wiggin and Dana LLPNational Law Review, Volume X, Number 230

About this Author

Michael Clear Estate and Trust attorney Greenwich Wiggin and Dana

As a Partner in the firm's Private Client Services Department, Michael regularly counsels clients on the far-reaching financial implications of estate planning, estate and trust administration, probate litigation, and business succession planning. Yet he is also a trained counselor with insight into the family dynamics these matters can effect. Known for his empathy and good humor, he helps clients take prudent action in the face of indecision, hopefully resolving contested issues before litigation.

Michael's estate planning practice includes assisting individuals and families in...