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Family Loans: Should You Lend It or Give It Away?

It may be better to give than to receive—but what about to lend?

Many well-off individuals choose to extend a helping hand to family members, be it a down payment on a new home, a bridge loan when times turn tough or even an advance on an inheritance. But how they give can be as consequential as how much.

That’s because there are potential tax implications depending on whether such financial assistance comes in the form of a family loan—to be paid back at a later date, with interest—or an outright gift. And while loans are often seen as furthering financial discipline, gifts may be less likely to foster conflict, since by definition they often come without formal strings attached.

So which one’s right for your family, and under what circumstances? Start by considering the following.

Gifts

Generally speaking, if an individual gives away more than $15,000 to another person in 2019, the donor must report the gift to the IRS on a Form 709. But that doesn’t necessarily mean you’ll owe taxes on it, thanks to the lifetime gift tax exemption, which is the total amount you can give away tax-free during your lifetime. (A gift may be excluded from one’s lifetime limit if the money is paid on another’s behalf directly to the provider to cover certain costs, including medical and tuition expenses.)

Before the Tax Cuts and Jobs Act of 2017, the lifetime gift tax exemption was $5.49 million for individuals and $10.98 million for married couples. The new law significantly increased that amount—to $11.4 million for individuals and $22.8 million for married couples in 2019—but there’s a catch. The boost is good only through 2025 (barring an extension), which is encouraging some individuals to transfer wealth from one generation to the next before the exemption potentially drops back down.

“If you have significant means and you’re primarily concerned with your tax exposure, then it may make sense to give money or other assets to family members before this window closes,” says Anh Bishop, a Schwab wealth strategist in Westlake, Texas.

That said, even the older exemption limit was so high that most taxpayers didn’t worry about exceeding it. “For most people, estate and gift taxes haven’t been of primary concern for some time—and that’s doubly true today with the increase in the exemption,” Anh says.

Loans

For those who don’t want to give an outright gift, an intrafamily loan, which can encourage fiscal discipline in the form of regular repayments, is another way to go. “You don’t necessarily want to give your kids everything without them having to work for it,” Anh says. “A family loan can serve as the foundation for financial independence.”

Before you extend a loan to family, however, be aware that it’s not as simple as just writing a check. The IRS mandates that any loan between family members be made with a signed written agreement, a fixed repayment schedule and a minimum interest rate. (Applicable Federal Rates [AFRs] are published monthly.) Should you fail to charge an adequate interest rate, the IRS could tax you on the interest you could have collected but didn’t. What’s more, if the loan exceeds $10,000 or the recipient of the loan uses the money to produce income (such as by using it to invest in stocks or bonds) you will need to report the interest income on your taxes.

There’s also the question of delinquency to consider. If a family member can’t repay a loan, it’s rarely reported to a credit bureau, never mind a collection agency. However, should the lender want to deduct a bad loan on her or his taxes, the IRS requires proof that there was an attempt to collect the delinquent funds. Conversely, if the lender wants to forgive the loan, the unpaid amount will be treated as a gift for tax purposes, and the borrower may owe taxes on the remaining unpaid interest. (The rules are even more complicated if the loan is considered a private mortgage, so it’s best to consult a qualified tax advisor or financial planner before finalizing the details.)

“Don’t think you can give a large amount of money and call it a loan in name only,” Anh says. “An intrafamily loan needs to have a formal structure. If not, you might be better off just gifting the money.”

Be that as it may, lending a large sum to a family member can help her or him save a tidy sum in interest payments over the life of the loan (see “All in the family,” below).

 

All in the family

Intrafamily loans, which can be offered at rates lower than those for mortgage and personal loans, can help borrowers save big on interest.

 

Intrafamily loan

Mortgage

Personal loan

Loan amount

$100,000

$100,000

$100,000

Interest rate

2.91%*

3.67%

9.80%

Loan term

15 years

15 years

15 years

Total interest paid

$23,527.05

$30,186.80

$91,232.51

*IRS.gov, as of 02/2019. Total interest paid assumes a fixed interest rate and a loan term of nine or more years.

Bankrate.com, as of 02/08/2019. Total interest paid assumes a 15-year fixed-rate mortgage and 20% down payment.

Bankrate.com, as of 02/08/2019. Total interest paid assumes a fixed interest rate and a credit score from 720 to 850. The example is hypothetical and provided for illustrative purposes only.

 

Family dynamics

In the end, whether to give a gift or extend a loan may come down to the strength of your familial relationships and the nature of the individuals involved. But whichever path you take, communication is key, particularly when it comes to setting expectations. “It’s just like any other family dynamic,” Anh says. “The more you talk and share your feelings, the less room there is to veer off track.”

What You Can Do Next

  • Read more about managing lifetime gifts.
  • Need help deciding whether to gift or lend money to a family member? Call 800-355-2162 to speak with a Schwab investment professional.
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Important Disclosures:

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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