The Family Bank: Intra-Family Loans & The AFR Strategy
The Family Bank: Intra-Family Loans & The AFR Strategy
Stop paying interest to strangers. How to lend money to your heirs at the lowest legal rate (AFR), avoid gift taxes, and keep the interest payments inside the family.
Executive Summary
- The Concept: Instead of giving a child $1M to buy a house (which eats into your Gift Tax Exemption), you lend them the money. They pay interest to you (the Family Bank) instead of paying Wells Fargo.
- The AFR Advantage: The IRS sets the “Applicable Federal Rate” (AFR) monthly. This is the minimum interest rate you must charge to avoid gift tax. The AFR is almost always lower than commercial bank rates.
👉 Example: Bank Mortgage = 7%. Mid-Term AFR = 4%. Your child saves 3% annually. - Wealth Transfer Arbitrage: If the child invests the borrowed money (e.g., in a business) and earns a 10% return, while paying you only 4% interest, the 6% spread is wealth transferred to them tax-free.
The “Sham Loan” Trap
IRS Warning: If you don’t enforce the loan, it’s a gift. To be a valid Intra-Family Loan:
1. You must have a signed Promissory Note.
2. You must enforce the Interest Payments (annually or accrued).
3. There should be a realistic expectation of repayment.
⚠️ Note: The interest you receive is taxable income to you.
Mechanic: Keeping Interest in the Family
Simulation: $1 Million Home Purchase (Bank vs. Family Loan)
| Feature | Outright Gift | Commercial Loan | Intra-Family Loan |
|---|---|---|---|
| Gift Tax Impact | Eats Exemption | None | None (if >AFR) |
| Cost to Heir | $0 (Free) | High Interest | Low Interest (AFR) |
| Behavioral Impact | Dependency | Independence | Accountability + Support |
“Gifts create dependency; loans create partnership. The Family Bank allows you to support your children’s ambitions while teaching them the cost of capital. It turns the family fortune into a revolving credit facility for the next generation.”