Another busy home-buying year is upon us. Much like last year, supply is low. But so are interest rates, and many of us are more than willing to sell our houses, then use the proceeds to buy new homes and lock in what are still historically low interest rates (even if the Federal Reserve starts to hike rates).
Most people will go to a bank to get a new mortgage. However, if you not only want to help a son or daughter buy their dream home but also save on your estate taxes, gifting by way of an intra-family loan can be a powerful estate planning tool. You can use intra-family loans to transfer wealth during your lifetime, free of taxes, as you help out a family member. Consider the strategy a way to take advantage of the largest estate tax exclusion and lowest interest rates we may see for decades.
In many instances, the annual gift tax exclusion, currently up to $16,000 per person or $32,000 for married couples tax-free, is sufficient incentive to pass along wealth to a next generation. However, you might want to gift more and sooner—and take advantage of the current, record-high $12.06 million gift and estate tax exemption—to reduce your estate and pay off your child’s or grandchild’s house earlier. In 2026, the exemption will revert to $5 million, pending future legislation.
Intra-family loan considerations
There are some important factors to consider in an intra-family loan to make sure you are in compliance with IRS rules. While the law allows you to lend the money to your family member in order to purchase a new home, you must charge at least the minimum interest rate—the Applicable Federal Rate (AFR), which is set by the IRS—for the month you are lending the money. The rate depends on whether the loan is short-, mid-, or long-term, and how often the interest is compounded. For example, the March 2022 AFR for an annual compounding loan for nine years is 1.74 percent.
Interest on the loan is taxable income to the lender and can be further complicated if the AFR is not used. However, you can use the lifetime gift exemption on an annual basis to forgive loan payments and interest. As such, you can reduce your estate by the amount of the loan as you further help out a family member. As well, the money may continue to appreciate as the value of real estate increases, but in the estate of the recipient of the loan.
In addition to the potential estate tax savings, the intra-family loan allows you to eliminate closing costs and costs for the processing and underwriting associated with traditional mortgages.
Documentation and counsel
To avoid errors and tax problems down the road, an intra-family loan should be carefully documented with a formal promissory note. Therefore, it is important to discuss this option with your financial advisor, accountant, and attorney.
IMPORTANT DISCLOSURES
The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.
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The historical and current information as to rules, laws, guidelines or benefits contained in this document is a summary of information obtained from or prepared by other sources. It has not been independently verified, but was obtained from sources believed to be reliable. HBKS® Wealth Advisors does not guarantee the accuracy of this information and does not assume liability for any errors in information obtained from or prepared by these other sources.
HBKS® Wealth Advisors is not a legal or accounting firm, and does not render legal, accounting or tax advice. You should contact an attorney or CPA if you wish to receive legal, accounting or tax advice.
