Asset Transfers from Parents to Children - Is it a Gift or a Loan?

Feb 10

**Common mistakes parents should avoid.**

Parents and grandparents often give children and grandchildren financial help to purchase a home or get them through hard times. These acts of benevolence can be great, generous gestures with a lasting impact across generations of family members.

But these types of transfers can also create conflict in the family if parents and grandparents fail to properly document the transfer as a loan and how any such transfers should be counted or treated in the future in relation to transfers occurring after death.

In most States, a transfer is presumed to be a gift, not a loan.

From an IRS perspective, in order for a transaction to be considered a loan, the IRS looks for “an actual expectation of repayment and an intent to enforce the debt.”

Whether a transfer is a loan or a gift can have tax consequences as well as have unintended consequences as far as unequal treatment among heirs as far as the operation of the parent or grandparent’s estate plan with respect to post death bequests of assets.

So what should a parent do? The best way to prove a transfer was intended as a loan is to actually draft documentation to reflect that fact. This would include drafting a promissory note that includes important terms (such as the amount loaned, the interest rate to be charged,and the schedule of payments) and then have the child sign it as the borrower.

**Unfortunately, parents oftentimes don’t clearly designate how an asset transfer should be treated.**

Common Mistake #1:

Parents make large gift to a child 1 and in the interest of equality, want to make sure Children 2 and 3 receive identical gifts during the parents' lives or after their deaths; however, the parents do not tell their accountant or lawyer about the gift,and they do not update their estate planning documents.

Solution:

For an annual gift exceeding $15,000.00 from each parent to a single child, a form 709 gift tax return must be filed with the IRS by the gift giver-or else penalties may result for late filing and late payment. Always Make sure to discuss planned gifts with your tax professionals before making the gift so that you understand of the consequences and so you can also make any appropriate amendments to estate planning documents to avoid any unintended consequences as far as how a pre-death transfer/gift should be accounted for post-death.

Common Mistake #2:

Parents transfer money to a child before deciding whether to treat it as a gift or a loan,usually based on the mistaken assumption they will”figure it out later”.

Solution:

“Figure it out later” is not a viable strategy. Instead, parents should document the transfer to the child as a family loan using a promissory note (and a mortgage in some circumstances). One attractive option for intra-family loans is to include an interest rate in the note,known as the Applicable Federal rate or AFR (the interest imputed to have been paid and received under the internal revenue code). The child is then charged the absolute minimum market rate of interest,and the parent can decide each year whether to collect the interest payment and principal or to forgive up to 15,000 by each parent as a gift to the child without creating gift and estate tax consequences.