Thursday, November 16, 2017
The Family Bank
by Steve Haberstroh, Partner
Weâ€™ve all heard of Bank of America, JPMorgan, and Wells Fargo, but many wealthy families are increasingly looking to family members to help finance a home or new business venture. Going into business with family certainly can be tricky but if you have a good relationship with a wealthy family member, such loans may make sense. Itâ€™s important at this point to state that we are not giving either legal or tax advice. You should consult with competent counsel and accountants to ensure that any loans between family members comply with IRS Guidelines.
In order to pass muster with the IRS, family loans must contain a promissory note, must spell out a fixed repayment schedule, and must comply with Applicable Federal Tax Rates(AFRs) per IRS guidelines. AFRs are updated monthly and can be found here: https://apps.irs.gov/app/picklist/list/federalRates.html. The person lending the funds will earn taxable interest.
Provided these loans are structured properly, the key benefits are:
- Interest Rates are typically lower than those obtained through a traditional bank. The October 2017 IRS minimum rates for family loans are as follows (compounded annually):
- Short Term (0-3 years): 1.27%
- Medium Term (3-9 years): 1.85%
- Long Term (9+ years): 2.50%
- Unless you typically “cheap out” on Secret Santa gift exchanges, your family member is unlikely to charge you closing costs, appraisal fees, underwriting fees, etc.
- Quick closing process with a family member compared to 30 days or more for mortgage financing through a traditional bank
- Interest is earned by and paid to a family member which keeps family wealth within the family
We have seen many successful outcomes using the family loan strategy. Some common scenarios are:
- Mom and Dad help with a daughterâ€™s down payment on their first home (or help finance the entire purchase)
- Grandma and Grandad fund a grandchildâ€™s business venture or startup
- Uncle Joe helps nephew buy out his successful real estate holding company
Remember, the IRS looks at these arrangements very closely so both sides of the transaction must comply with IRS tax code. But if structured properly, family loans can be a terrific way to leverage existing wealth and “keep it in the fam.”