When mortgage rates are sky-high, buying a home can feel out of reach. But what if a family member could step in as the lender, offering better terms than a bank?
That’s exactly what one couple in Tampa is doing. They plan to lend their granddaughter $200,000 for a down payment on a house, with an interest rate of 6%. Each year they plan to forgive $30,000 of the loan as a gift.
That’s a smart move but the tax rules can be tricky. Here’s how to make it work without running afoul of the IRS.
Why an Intrafamily Loan?
With today’s mortgage rates still elevated, a loan from a relative can be really helpful. Parents or grandparents can act as the bank, offering lower interest rates and more flexible terms.
But in order to avoid tax headaches, the loan needs to be structured properly.
Setting Up the Loan the Right Way
First, be upfront with the mortgage lender (if there is one). Banks usually require full disclosure of any outside loans used for a down payment. If the buyer doesn’t mention the family loan, they could face legal trouble or even loan denial.
If the family is providing the entire mortgage—not just the down payment—both sides should get professional help to draft a formal agreement. This protects everyone, and the IRS sees it as a real loan, not a gift in disguise.
The IRS’s Minimum Interest Rate
The IRS doesn’t like it when families lend money at below-market rates. To keep things above board, the interest rate on the loan must meet or exceed the Applicable Federal Rate (AFR)—a benchmark set monthly by the IRS.
For long-term loans (over nine years), April 2024’s AFR was around 4.5%—far lower than most mortgage rates today. If the rate on the family loan is too low, the IRS could “impute” extra interest, creating phantom income for the lender.
The good news, though, is that if market rates fall later, the loan can be refinanced just like a traditional mortgage.
Tracking Payments and Taxes
The borrower should make regular interest payments, and the lender should keep detailed records—dates, amounts and any forgiven principal.
For the lender, the interest received is taxable income. As for the borrower, it may be tax-deductibleif it qualifies as mortgage interest (check IRS Publication 936 for details).
The Gift-Tax Loophole
Where things get interesting is that the Tampa couple plans to forgive $30,000 of the loan each year, turning debt into a gift.
Under current tax rules, each person can gift up to $18,000 per year (in 2024) to any individual without triggering gift taxes. This means a couple could forgive up to $36,000 per year ($18,000×2) without tax consequences. If their granddaughter is married and both spouses are on the loan, the couple could forgive up to $72,000 annually ($18,000×4).
But the problem is that the IRS doesn’t like “scheduled” forgiveness.
Beth Shapiro Kaufman, a gift and estate attorney, advises making the forgiveness look spontaneous. Don’t set a fixed amount to forgive each year, she says. Rather, vary the amounts, skip a year occasionally and make it feel like a genuine act of generosity.
What If the Loan Is for the Whole House?
Forgiving a down payment is one thing but wiping out a $500,000+ mortgage over time is much harder. At $36,000 per year, it could take well over a decade, and the lender may not live long enough to forgive the full amount.
In that case, the family may need to consider other strategies, like forgiving part of the debt in a will. And if there are multiple children or grandchildren, fairness becomes another thing to navigate.
Why Not Just Give the Money (or the House) Outright?
Some families do. But Kaufman says many prefer loans for a few reasons.
- “Skin in the game”—The borrower feels more responsible if they’re making payments.
- Fairness among siblings—If one child gets a house, others might expect equal treatment.
- Tax exemptions maxed out—Some wealthy families have already used up their lifetime gift-tax exemption.
Conclusion
An intrafamily loan can be a win-win, helping a loved one buy a home while offering better terms than a bank. But the IRS has strict rules and missteps can mean unexpected taxes or legal trouble.
If you’re considering this route, get professional advice to structure the loan correctly. That way, you can keep the taxman happy and keep the peace in the family, too.
