Preservation | Family Wealth Protection & Planning


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Tax Planning in Uncertain Times: Making or Refinancing Loans
By Jennifer Davis, Elizabeth Pack on July 27, 2020 at 3:00 PM

This is the third installment in a seven-part blog series on opportunities for tax planning in the current low-interest rate environment. Read our previous installments here. Future installments will cover creating Grantor Retained Annuity Trusts, family limited partnerships and limited liability companies, installment sales to defective grantor trusts, and charitable giving.

A simple method for transferring assets in a tax-efficient manner is by making low interest rate loans to family members. For example, a child wants to buy their first home. Rather than the child paying interest to a bank, the parent can loan the child money for the purchase price at an interest rate equal to the Applicable Federal Rate (AFR). The AFR is the lowest interest rate that may be charged on a loan without causing negative gift tax consequences. This allows for the payment to be more economical for the child, and the interest amount to stay within the family rather than being paid to a third-party bank.

Currently, the AFR is at a historical low. In January 2020, the mid-term AFR (for loans more than three years and up to nine years) was 1.69 percent. The mid-term AFR for July 2020 is 0.45 percent (set to decrease to 0.41 percent in August 2020).

Intra-family loans can also provide more flexibility for the borrower over a commercial loan. A child or grandchild can use such a loan to start a business, make other investments, pay down higher-interest debt, or as mentioned above, purchase a home or car. The current low AFR as well as depressed asset values may create a higher probability that the rate of return on an investment of the loan proceeds will exceed the interest payments, allowing any future appreciation to pass to the borrower gift and estate tax free. A parent or grandparent may also choose to forgive part or all of the loan payments, periodically, using the annual exclusion amount if they wish to prevent such gift from using up any of his or her lifetime gift/estate tax exemption amount.

For an individual who has already engaged in this type of planning, that individual should consider possibly modifying existing loans that have been made to family members in order to take advantage of the historically low interest rates. Refinancing such existing loans is generally a fairly simple process.

Please contact someone in our Trusts & Estates Practice Group if you are interested in making a loan to a family member or if you would like to modify an existing loan to take advantage of the historically low rates.

Stay tuned for Part 4 of this series where we will discuss planning opportunities using Grantor Retained Annuity Trusts.

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