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Intra-Family Loans – Promissory Notes – Appraisal and Valuation

Basic Information

Definition

An intra-family loan is an estate-planning technique using a promissory note. The Internal Revenue Service sets forth rules that allow family members to make loans to other family members at lower interest rates than those charged by commercial lenders, without it being deemed a gift. The lender, usually a parent or grandparent, must charge interest to avoid making a gift to the borrower, but this interest rate may be very low (below market rate), with annual payments of interest only, as contrasted to monthly principal and interest payments. The loan can be structured as a “balloon balance note”, meaning the borrower pays interest only during the term of the loan, and then repays the entire principal at the end of the term.

From a cash-flow point of view, an intra-family loan, using this structure can be beneficial for the borrower. Because it benefits the borrower, it is detrimental to the value of the lenders promissory note.

Types of Intra-Family Notes

• Loans to family members

• Installment sales to family members

• Self-canceling installment notes to family members

Benefits

Intra-family loans create wealth shifting opportunities; wealth can be shifted from one family member to another family member, usually a child or grandchild, without incurring a tax liability. If the child or grandchild can earn a greater return on the amount borrowed than the low interest rate charged on the loan, he or she can keep the excess income with no gift taxes being paid. Wealth is transferred tax-free.

The required interest rate is set by the government monthly; it is called “AFR”–Applicable Federal Interest Rate. The actual interest rate used depends on the length of the loan; all of the current AFRs are very low compared to market interest rates.

Another benefit of intra-family loans is keeping the interest dollars paid within the family rather than paid to an outside party. The loan terms can be tailored to the…

Read More…. by Lawrence Tepper

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