Be the Bank: Intra-Family Loans & The AFR Strategy
Be the Bank: Intra-Family Loans & The AFR Strategy
Stop giving your children money; start lending it. How to use the “Family Bank” to finance your heir’s first home or startup at rates far below the market, without triggering a penny of gift tax.
Executive Summary
- The Dilemma: Your daughter wants to buy a $2M home. Mortgage rates are 7%. If you give her $2M cash, you use up $2M of your Lifetime Gift Exemption (or pay 40% tax). If she borrows from a bank, she pays massive interest to strangers.
- The Solution (Intra-Family Loan): You lend her the $2M. The IRS requires you to charge a minimum interest rate called the **Applicable Federal Rate (AFR)**. The AFR is almost always *lower* than commercial mortgage rates.
- The Wealth Transfer:
👉 Market Rate (7%) vs. AFR (e.g., 4%).
👉 Your daughter saves 3% in interest annually. This saving is a **Tax-Free Gift**.
👉 If the house appreciates at 5%, she keeps all the upside. You essentially transferred the asset’s growth to her without using your exemption.
The “Sham Transaction” Trap
Paperwork is Mandatory: You cannot just write a check and say “pay me back later.” The IRS will reclassify undocumented loans as **Gifts**, triggering immediate taxes.
👉 The Protocol: You must have a signed **Promissory Note**. You must record a **Mortgage Lien** (Deed of Trust) if it’s for a house. You must collect interest payments annually and declare them as income on your tax return. Treat it like a real business.
Mechanic: The AFR Arbitrage
Simulation: Funding a $2M Home Purchase (Bank vs. Dad)
| Feature | Outright Gift | Intra-Family Loan |
|---|---|---|
| Gift Tax Exemption | Used Immediately (100% Value) | Preserved ($0 Used) |
| Asset Protection | Exposed to Child’s Divorce | Protected (Dad is a Creditor) |
| Psychology | Entitlement (“My Money”) | Responsibility (“Debt to Repay”) |
“Money ruins children when it is given without context. The Family Bank changes the dynamic from ‘Parent-Child’ to ‘Lender-Borrower.’ It allows you to help them, while maintaining the leverage to enforce good behavior.”