Taxpayer Win: Intrafamily Loan Charging the Applicable Federal Interest Rate Is Not a Gift
Intrafamily loans are a powerful estate planning tool — but they’re often misunderstood. Many families worry that lending money to children or relatives will automatically be treated as a taxable gift by the IRS. A recent taxpayer-friendly outcome reinforces an important principle: 👉 When an intrafamily loan charges at least the Applicable Federal Interest Rate (AFR) and follows proper formalities, it is NOT a gift. This clarification is a win for families using smart lending strategies to transfer wealth efficiently.
What Is an Intrafamily Loan?
An intrafamily loan is exactly what it sounds like — a loan made between family members, often:
Parents lending to children
Grandparents lending to grandchildren
Loans to help buy a home
Loans to start or expand a business
Loans to refinance high-interest debt
These loans are commonly used to:
✔ Help family members financially
✔ Reduce estate size over time
✔ Keep wealth within the family
✔ Avoid unnecessary gift taxes
Why the IRS Scrutinizes Intrafamily Loans
The IRS closely examines family loans because informal arrangements can look like disguised gifts.
If a loan:
Has no interest
Charges interest below market rates
Has no repayment terms
Lacks documentation
…the IRS may recharacterize it as a taxable gift, potentially triggering gift tax or use of your lifetime exemption.
The Key Rule: The Applicable Federal Interest Rate (AFR)
To avoid gift treatment, an intrafamily loan must charge at least the AFR in effect at the time the loan is made.
What is the AFR?
The AFR is a minimum interest rate published monthly by the IRS for:
Short-term loans (3 years or less)
Mid-term loans (over 3 years to 9 years)
Long-term loans (over 9 years)
These rates are often lower than commercial bank rates, making them attractive for family planning.
Why This Is a “Taxpayer Win”
When a loan:
✔ Charges at least the AFR
✔ Is properly documented
✔ Includes a promissory note
✔ Has a repayment schedule
✔ Reflects real intent to repay
…the IRS treats it as a legitimate loan, not a gift.
This means:
No immediate gift tax
No use of lifetime exemption
No imputed interest penalties
No reclassification of loan principal as a gift
Any interest paid back to the lender is taxable income — but the principal remains a loan, not a transfer of wealth.
Estate Planning Benefits of AFR Loans
Intrafamily AFR loans can be especially powerful when:
✔ Interest rates are low
If the borrower earns or invests at a rate higher than the AFR, the excess growth benefits the borrower—not the lender’s estate.
✔ Helping with large purchases
Homes, real estate investments, or business ventures can be financed without bank involvement.
✔ Reducing taxable estates
The loan removes cash from the lender’s estate while replacing it with a receivable of fixed value.
✔ Pairing with other strategies
AFR loans are often combined with:
Trust planning
Family LLCs
GRATs
Sales to intentionally defective grantor trusts (IDGTs)
What Can Go Wrong (and How to Avoid It)
Even when charging AFR, loans can still fail if:
❌ There’s no written promissory note
❌ Payments aren’t actually made
❌ Terms are repeatedly ignored
❌ Loans are “forgiven” without gift reporting
❌ Records are sloppy or nonexistent
Formality matters.
Family loans must look and act like real loans.
Important Reminder: Documentation Is Everything
A proper intrafamily loan should include:
Written promissory note
Clear interest rate (AFR or higher)
Defined repayment schedule
Maturity date
Security (when appropriate)
Records of payments
Treat it like a bank would — because the IRS will.
Final Thought: Smart Lending Is Smart Planning
This taxpayer win reinforces what estate planners have long known:
Intrafamily loans, when structured correctly, are legitimate and powerful planning tools — not gifts.
Used properly, they allow families to:
Help loved ones
Preserve wealth
Reduce estate taxes
Take advantage of low interest rates
Keep planning flexible
But like all advanced strategies, they must be done right.