An intrafamily loan is a financial arrangement in which one family member lends money to another.
These loans are often made from a parent or grandparent to a child or grandchild. They may offer more flexible terms than a traditional bank loan, but they still need to be structured and documented as genuine loans.
An intrafamily loan may help a family member:
- Buy a home
- Fund or purchase shares in a business
- Add property to an investment portfolio
- Pay down high-interest debt
- Cover education expenses
- Start or expand a business
Lending to a child or grandchild can be satisfying. Your loved one may receive a lower interest rate or more flexible repayment terms while learning financial responsibility.
The arrangement may also provide interest income to the lender.
However, an informal transfer of money between relatives can create tax problems and family conflict. A properly structured intrafamily loan should include a written agreement, an adequate interest rate, a repayment schedule, and evidence that the parties intend to enforce the debt.
What Is an Intrafamily Loan?
An intrafamily loan is a legally enforceable loan between relatives.
The borrower receives money and agrees to repay it according to specific terms. Those terms should identify:
- The amount borrowed
- The interest rate
- The repayment schedule
- The loan term
- Whether the loan is secured
- What happens after a missed payment
- Whether early repayment is permitted
- What happens if either party dies
A family loan should not be treated as an informal promise that can be changed or ignored whenever convenient.
If the arrangement does not resemble a real loan, the IRS may treat some or all of the transfer as a gift.
When Should You Consider an Intrafamily Loan?
The right way to provide money to a family member depends on your goals, finances, and family circumstances.
An intrafamily loan may be useful when:
- The borrower cannot qualify for favorable commercial financing
- The lender wants to retain the right to repayment
- The parties want more flexible terms than a bank offers
- A family member is purchasing a home or business
- The family is planning an intergenerational wealth transfer
- The lender wants interest income
- The borrower expects an investment to earn more than the loan’s interest rate
An intrafamily loan is not automatically better than a gift. The parties must consider income tax, gift tax, estate tax, cash flow, and the possibility that the borrower may default.
How Can an Intrafamily Loan Help With Estate Planning?
Intrafamily loans can transfer future growth to younger family members while allowing the lender to retain the right to receive principal and interest.
Assume a parent lends money to a child, and the child invests it. If the investment earns more than the interest charged on the loan, the child generally keeps the excess growth.
The lender’s estate still includes the value of the outstanding loan. This usually consists of the remaining principal and any accrued interest owed to the lender.
However, investment growth above the required interest rate may occur outside the lender’s estate.
Current Federal Estate and Gift Tax Exemption
For 2026, the federal basic exclusion amount is $15 million per individual. The law provides for inflation adjustments beginning in 2027.
Most families will not owe federal estate tax under the current exemption. However, intrafamily loans may still be useful for families with appreciating businesses, real estate, investments, or other substantial property.
Tax laws and exemption amounts can change. Families should review current rules before completing a large transfer.
Preserving the Lender’s Lifetime Exemption
A properly structured loan is not treated the same way as an outright gift.
Because the borrower must repay the principal and interest, the original transfer generally does not use the lender’s lifetime gift and estate tax exemption.
If the parties do not observe the loan formalities, however, the IRS may argue that the transfer was actually a gift. This could create gift-tax reporting obligations and reduce the lender’s remaining exemption.
Can You Make an Intrafamily Loan to a Trust?
A family member may lend money to a trust created for children, grandchildren, or other beneficiaries.
The trust can invest the loan proceeds. If the investment return exceeds the required interest rate, the additional growth may remain in the trust for the beneficiaries.
The trust must still repay the loan according to its terms.
This strategy can be more complicated than lending directly to an individual. The trust document, tax treatment, trustee’s authority, and loan terms must all be reviewed.
A loan to a trust should be coordinated with an estate planning attorney and qualified tax advisor.
What Is the Applicable Federal Rate?
The Applicable Federal Rate, commonly called the AFR, is a minimum interest rate published monthly by the IRS.
The appropriate AFR generally depends on the length of the loan:
- Short-term AFR: Loans of three years or less
- Mid-term AFR: Loans longer than three years but not longer than nine years
- Long-term AFR: Loans longer than nine years
The IRS publishes current and historical rates on its Applicable Federal Rates page.
Rates may also vary based on whether interest is compounded annually, semiannually, quarterly, or monthly.
Why Does the AFR Matter?
A family lender can often charge less interest than a commercial bank. However, the rate should generally be at least the AFR that applies when the loan is made.
If the interest rate is below the required rate, the loan may be classified as a below-market loan.
The IRS may then impute interest. This means the lender could be treated as having received interest income that was never actually paid.
The unpaid interest may also be treated as a gift from the lender to the borrower.
Does Every Family Loan Need to Charge Interest?
Federal law contains exceptions for certain small below-market loans, including some loans of $10,000 or less. However, these exceptions are limited and depend on how the borrower uses the money.
There are also special rules for certain gift loans between individuals when the total outstanding amount does not exceed $100,000. The amount of imputed interest may depend on the borrower’s net investment income.
Because the exceptions are technical, families should not assume that a loan under a particular dollar amount can automatically be interest-free.
A tax advisor should determine whether an exception applies.
How Do Current AFRs Affect a Family Loan?
The AFR changes monthly.
For example, the IRS listed the following annual rates for August 2026:
- Short-term AFR: 4.10 percent
- Mid-term AFR: 4.35 percent
- Long-term AFR: 5.05 percent
These rates apply only to the relevant period and compounding method. The correct rate is generally determined when the loan is created.
The IRS August 2026 revenue ruling provides the complete tables.
Because rates change every month, the loan documents should identify the rate used and the date on which the loan was made.
Can an Intrafamily Loan Be Refinanced?
A family loan may sometimes be refinanced if interest rates fall.
However, replacing or modifying a promissory note can have tax and legal consequences. The change could be treated as a new loan, a modification of an existing debt, or, in some situations, a partial gift.
The parties should not simply reduce the interest rate without documentation.
An attorney and tax advisor should review any proposed refinancing to determine:
- Whether a new promissory note is needed
- Which AFR applies
- Whether accrued interest must be paid
- Whether the old note should be cancelled
- Whether the modification creates a taxable gift
- Whether a mortgage or other security document must be updated
How Should an Intrafamily Loan Be Documented?
The parties should sign a comprehensive written promissory note.
The note should comply with applicable state law and clearly establish that the transfer is a loan rather than a gift.
The documentation may include:
- The names of the lender and borrower
- The principal amount
- The interest rate
- The payment schedule
- The maturity date
- The method of payment
- Late-payment provisions
- Default provisions
- Collateral or security
- Rights following the death of either party
- Signatures and dates
If real estate secures the loan, additional mortgage, deed of trust, recording, insurance, and title requirements may apply.
Follow the Payment Schedule
Signing a promissory note is not enough.
The borrower should make payments according to the schedule. The lender should keep records of principal and interest received.
The parties should avoid routinely ignoring missed payments or changing the terms without written documentation.
Evidence that the loan is treated like a real debt may include:
- Regular payments
- Bank records
- Written payment receipts
- Interest reporting
- Collection efforts following default
- Updated loan balances
- Proper tax filings
If the family never expects repayment, a gift may be the more accurate and appropriate structure.
How Are Interest Payments Taxed?
Interest received by the lender is generally taxable income.
The lender may need to report the interest on a federal income tax return even though the borrower is a relative.
Whether the borrower can deduct the interest depends on how the loan proceeds are used and whether other tax requirements are satisfied.
For example, interest on a properly secured loan used to purchase a qualified residence may receive different treatment from interest on a personal loan. Business and investment loans may also have different rules.
The parties should consult a tax advisor about income reporting and possible deductions.
Can Intrafamily Loans Help Transfer a Family Business?
Intrafamily loans can help transfer a family business from one generation to the next.
A parent may provide financing to a child who wants to purchase business interests but cannot obtain favorable commercial financing.
This may allow the business to remain in the family and provide the parent with a stream of principal and interest payments.
The transaction should still be based on reasonable terms. The business and ownership interest may need to be professionally valued.
The family should also coordinate the loan with:
- Corporate or operating agreements
- Buy-sell agreements
- Ownership restrictions
- Business succession plans
- Life insurance
- The lender’s estate plan
- The borrower’s estate plan
A poorly documented business transfer can create disputes among owners, family members, and tax authorities.
What Happens If the Borrower Cannot Repay?
Default is not merely a tax issue. It can create serious tension within the family.
Before making the loan, ask whether you are prepared to enforce it.
Questions may include:
- Will you charge late fees?
- Will you demand payment after a default?
- Will you foreclose on collateral?
- Could the borrower lose a home or business?
- Would forgiving the debt create a taxable gift?
- How would default affect your relationship?
- Can you afford to lose the money?
If you would never enforce the agreement, reconsider whether the transfer should be structured as a loan.
How Can an Intrafamily Loan Affect Other Children?
A loan to one child may appear unfair to other children, even when the borrower is required to repay it.
Before making the loan, consider:
- Will the loan reduce what other children inherit?
- Will loans be available to other children?
- Should different children receive different terms?
- Will unpaid balances be deducted from the borrower’s inheritance?
- What happens if the borrower defaults?
- Will forgiving the loan create resentment?
- Who will enforce the loan after the lender’s death?
Clear communication and careful estate planning can reduce misunderstandings.
What Happens to the Loan When the Lender Dies?
An unpaid family loan does not automatically disappear when the lender dies.
The promissory note is generally an asset of the lender’s estate or trust. The personal representative or successor trustee may be responsible for collecting the remaining balance.
The estate plan should state whether the debt will:
- Remain payable under the original terms
- Become immediately due
- Be forgiven
- Be deducted from the borrower’s inheritance
- Pass to another beneficiary
- Continue to be administered by a trust
If the debt is forgiven at death, the forgiveness may affect the borrower’s inheritance and could have tax consequences.
The plan should also explain how the loan affects equal or unequal distributions among beneficiaries.
Gift or Loan: Which Is Better?
The decision depends on the family’s goals and finances.
A gift may be appropriate when:
- Repayment is not expected
- The donor can afford to give up the money permanently
- The transfer fits within the donor’s tax and estate plan
- The family wants a simple transaction
A loan may be appropriate when:
- Repayment is expected
- The lender wants to preserve access to the principal
- The borrower needs favorable financing
- The lender wants interest income
- The family wants to transfer future investment growth
The income, estate, and gift-tax rules surrounding intrafamily loans are complex. An incorrectly structured loan can create unintended tax consequences.
We Can Help Coordinate a Family Loan With Your Estate Plan
If you already have an intrafamily loan, it is important to document it in your estate plan. This can help ensure that the loan is handled properly if you die before it is repaid.
McDonald Law Firm can work with you and your tax advisor to determine whether an intrafamily loan is appropriate and how it should be coordinated with your will, trust, and beneficiary distributions.
Attorney André O. McDonald assists clients in Howard County, Montgomery County, and the District of Columbia with estate planning, special needs planning, Medicaid planning, and related matters.
To schedule a consultation, call:
- Howard County: 443-741-1088
- Montgomery County: 301-941-7809
- District of Columbia: 202-640-2133
DISCLAIMER: THE INFORMATION POSTED ON THIS BLOG IS INTENDED FOR EDUCATIONAL PURPOSES ONLY AND IS NOT INTENDED TO CONVEY LEGAL, INSURANCE, OR TAX ADVICE.
