Where Intra-Family Loans Fit in a Modern Estate Plan

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Loans are not a sideshow to the estate plan - they can be one of its most flexible instruments.

Intra-family loans are usually treated as a side matter, separate from the estate plan. They are more useful than that, and when ignored, they are one of the more reliable sources of conflict after a death.

A loan is an estate asset

Start with the mechanics. An outstanding loan to a family member is a receivable, and it is part of the lender's estate. It has a value, it will be inventoried, and somebody will inherit the right to collect it.

That single fact drives most of what follows. If a parent lends $300,000 to one child and dies with the balance outstanding, the estate now contains a claim against that child, and the other children are, in effect, inheriting the right to be repaid by their sibling.

Handled deliberately this is unremarkable. Handled by silence it is corrosive.

Three ways to treat an outstanding balance

• Collect it. The estate calls the loan and distributes the proceeds. Clean in principle, hard in practice if the borrower cannot readily pay.
• Offset it. The borrowing child's share is reduced by the outstanding balance. Usually the fairest treatment, and it requires the will or trust to say so explicitly.
• Forgive it at death. The will directs that the balance be cancelled. This is a real transfer to that child and should be accounted for when considering the others.

Any of these can be fair. What is not fair is leaving it undecided, so that the family works it out during probate.

Why documentation matters more here than anywhere

An undocumented family loan does not merely have tax problems. At an estate it has an evidentiary problem: the person who could confirm the terms has died.

What is left is siblings with different recollections. One remembers a loan; another remembers a gift; nobody has a balance. This is among the most common sources of estate litigation, and it is entirely a records failure. See how to document a family loan properly.

Loans as a planning instrument

Beyond avoiding harm, loans do things gifts cannot:

• Freeze value. Lending at the AFR so a child can acquire an appreciating asset leaves the estate holding a note growing at a fixed rate, while the appreciation accrues outside it.
• Transfer gradually. Annual forgiveness inside the gift-tax exclusion moves wealth steadily without consuming lifetime exemption.
• Retain flexibility. A gift is irreversible. A loan can be collected, offset or forgiven as circumstances evolve.
• Support advanced structures. Notes at the AFR are the mechanism behind techniques like sales to intentionally defective grantor trusts.

Keep the documents in agreement

The most common technical failure is a will and a loan file that contradict each other: a note requiring repayment, and a will forgiving it, with no indication which controls or whether the change was intended.

Whenever a loan is made, amended or forgiven, the estate documents should be reviewed alongside it. Two records, one story.

The practical rule

Any family loan large enough to matter should appear in three places: a signed note, a maintained balance, and an explicit instruction in the estate plan. Families that do all three rarely have a problem. Families that do none reliably do.

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General information, not tax or legal advice. Estate treatment varies by state and by document. Work with your own estate counsel.