Understanding Inter-Family Loans and Estate Planning

Quick answer: An intra-family loan lets one family member lend money to another at a set interest rate and repayment schedule. To avoid the IRS treating the loan as a taxable gift, the rate must equal or exceed the Applicable Federal Rate (AFR) published monthly by the IRS, and the deal needs to be documented in a signed promissory note. Done right, these loans can help transfer wealth, fund a child’s home purchase, or support a business launch—without triggering gift tax.

Lending money to a son, daughter, or sibling sounds simple. But the IRS has specific rules for what makes a family loan a loan rather than a gift. Miss those rules and you may owe gift tax you didn’t plan for. Get them right and you have a flexible tool for moving wealth down a generation at a fraction of what you’d spend on estate taxes later.

This post covers how intra-family loans work, what the IRS requires, how they fit into a broader estate plan, and what traps to avoid.

What Is an Intra-Family Loan?

An intra-family loan is a formal lending arrangement between relatives. One person (the lender, often a parent or grandparent) provides funds to another (the borrower, often an adult child). The borrower repays principal plus interest on a set schedule.

That last part matters. Without interest and a real repayment structure, the IRS may decide the transaction is a gift, not a loan, and apply gift tax rules.

How It Differs from a Gift

A gift transfers money with no expectation of repayment. An intra-family loan requires repayment with interest. The distinction determines whether gift tax applies. Loans that meet IRS rules are not counted against your annual gift exclusion (currently $18,000 per recipient in 2026) or your lifetime exemption.

The IRS Rules: AFR and Documentation

Two requirements define whether a family loan is treated as a loan for tax purposes.

Applicable Federal Rate (AFR)

The IRS publishes the AFR each month in a Revenue Ruling. The rate varies by loan term:

• Short-term (3 years or less): 3.85% for June 2026
• Mid-term (3 to 9 years): 4.13% for June 2026
• Long-term (over 9 years): 4.87% for June 2026

Source: IRS Rev. Rul. 2026-11, published at irs.gov/applicable-federal-rates.

If you charge less than the applicable AFR, the IRS will “impute” the missing interest under IRC §7872. That means the lender is treated as having received interest they didn’t actually collect, and the forgone amount may be treated as a taxable gift to the borrower. Depending on loan size, the borrower may also have taxable income.

One exception: loans of $10,000 or less are generally exempt from the imputed-interest rules. Loans between $10,001 and $100,000 have a softer rule if the borrower’s net investment income is $1,000 or less. For anything larger, charge at least the AFR.

Proper Documentation

The loan must look like a real loan on paper. At minimum you need:

• A signed promissory note stating the principal amount, interest rate, repayment schedule, and what happens on default
• Actual loan disbursement (a check or wire transfer, not cash)
• Regular, on-schedule interest payments that are actually made
• Records of any payments received by the lender

If the lender forgives payments informally, the IRS may recharacterize those forgiven amounts as gifts. If the borrower never makes a single payment, the IRS may treat the whole thing as a gift from the start.

Why Intra-Family Loans Work in Estate Planning

Intra-family loans aren’t just about helping a relative—they can be part of a deliberate wealth transfer strategy.

Spreading Wealth at Low Cost

When AFRs are below commercial lending rates, a parent can lend at, say, 4% instead of the 7% a bank might charge. The borrower saves money. The lender earns taxable interest income (which they report on their return) but has moved a significant sum without touching their gift or estate tax exemption.

Any appreciation on assets the borrower purchases or invests in with loan proceeds also stays outside the lender’s taxable estate. That’s the planning angle: get money working for the next generation now, at a modest, IRS-approved rate, and keep the growth out of your estate.

Funding Major Life Events

Common uses for intra-family loans include:

• A down payment on a first home
• Tuition or graduate school costs
• Startup capital for a family business
• Buying out a sibling’s share of inherited property

In each case, the borrower gets capital at below-market rates, and the lender has a documented asset on their books rather than a taxable gift on their return.

Using Loans Alongside Trusts

For larger transfers, intra-family loans are often combined with an irrevocable grantor trust. The lender sells assets to the trust in exchange for a promissory note bearing the AFR. Because the trust is a “grantor trust” for income tax purposes, no capital gains tax is triggered on the sale. The trust invests the assets; if they grow faster than the AFR, the excess passes to beneficiaries free of gift or estate tax. This technique is sometimes called a SLAT (Spousal Lifetime Access Trust) or IDGT (Intentionally Defective Grantor Trust) depending on the structure. An estate tax planning attorney can walk you through whether either fits your situation.

Risks and Mistakes to Avoid

Below-Market Rate Loans

Charging less than the AFR triggers the imputed-interest rules. The IRS taxes the lender on interest they never received and may treat the forgone amount as a gift. Avoid this by looking up the current AFR before you write the promissory note, then using that rate or higher.

Paper Loans with No Real Payments

If the borrower never makes a payment and the lender never asks for one, courts and the IRS may treat the whole arrangement as a sham. Use a bank transfer for disbursement. Set up automatic monthly payments. Keep records.

Informal Forgiveness

Forgiving a loan balance is a gift at the time of forgiveness. If a parent forgives $30,000 of principal at year-end, that forgiveness counts toward the annual gift exclusion and, if it exceeds $18,000, must be reported on a gift tax return. Plan forgiveness deliberately, not casually.

Unequal Treatment of Siblings

If one child gets a loan and another doesn’t, resentment can follow. Put the loan in writing. Consider whether the outstanding balance will be counted against that child’s eventual inheritance. Document the decision in your estate plan so there’s no ambiguity later.

Structuring the Loan: A Checklist

• Look up the current AFR at irs.gov for the month you’re making the loan
• Draft a promissory note with principal, interest rate, payment schedule, and default terms
• Have both parties sign the note
• Transfer funds by check or wire—not cash
• Make and receive actual payments on schedule
• Lender reports interest income on their tax return each year
• If you plan to eventually forgive the balance, track each forgiven amount against the annual gift exclusion
• Reflect the outstanding loan balance in the lender’s estate plan documents

Working with Ridley Law

Eric D. Ridley has helped Ventura County families structure estate plans since 2010. Intra-family loans are one piece of a larger puzzle that may include living trusts, powers of attorney, and tax planning. Getting the documentation right from the start avoids problems later—whether that means an IRS audit, a family dispute, or an estate that doesn’t go where you intended.

If you’d like to talk through whether an intra-family loan makes sense for your family, call Ridley Law at (805) 244-5291 or schedule a free consultation through the estate planning page.

Frequently Asked Questions

What interest rate must an intra-family loan charge to avoid gift tax?

The loan must charge at least the Applicable Federal Rate (AFR) for the month the loan is made. The IRS publishes three tiers: short-term (loans of 3 years or less), mid-term (3 to 9 years), and long-term (over 9 years). As of June 2026, those rates are 3.85%, 4.13%, and 4.87% respectively. Charging less triggers the imputed-interest rules under IRC §7872, which can treat the forgone interest as a taxable gift.

Does an intra-family loan need to be in writing?

Yes. A signed promissory note is essential. Without written terms, the IRS—and a probate court, if the lender dies with the loan outstanding—may treat the transaction as a gift. The note should specify the principal, interest rate, repayment schedule, and consequences of default.

Can a parent forgive the loan later without gift tax consequences?

Forgiveness of a loan balance is treated as a gift at the time of forgiveness. Each year’s forgiven amount counts toward the annual exclusion ($18,000 per recipient in 2026). If the forgiven amount exceeds that threshold, a gift tax return is required. Some families structure deliberate annual forgiveness as part of their gifting plan, but it needs to be intentional and tracked.

How does an intra-family loan fit into a California estate plan?

In California, an intra-family loan is typically documented alongside your living trust and schedule of assets. The outstanding loan balance is an asset of the lender’s estate. If the lender dies before repayment, the trust or estate has a claim against the borrower’s share of the inheritance—unless the plan directs otherwise. Spelling this out in the trust avoids sibling disputes about whether the loan was “really” a gift.