Why is it a good time to use intra-family loans and sales in estate planning?


April, 2010 |

“The bottom line in this scenario is that this family’s tax savings could exceed $2 million on the $5 million value of the home.”– Bill Loftus

Historically low interest rates and asset valuations make this possibly the best opportunity we will see in a generation to employ intra-family loans and sales. In fact, we consider them one of the last great gains in estate planning.

To illustrate just how effectively intra-family loans and sales can preserve your legacy, I am going to create a scenario for a family of five: Mom, Dad, three married children. We will present this family with a pair of challenges:

  1. If the parents own a home worth, say, around $3 million, how can they use the home to create wealth for their children, to minimize taxes, and to preserve family relationships?
  2. Let us also say the mother has a dynasty trust. How can this family use that trust to create a legacy for the family’s grandchildren?

For starters, we will also assume the parents have exhausted their gift tax exemptions. With that option o the table, an LLC would be created that would hold the property. Next, 50 percent of the property would be sold to the three children within the LLC, and then the parents would take back a note.

To meet federal requirements, a strategy like this would have to operate like a real sale or real loan, and here is where the historically low interest rate comes in. In March 2010, the applicable federal rate, calculated monthly by the IRS, had a rate of 0.64 percent for three years, 2.69 percent for three to nine years, and 4.35 percent for nine plus years. Additionally, over time, these parents can forgive some principal or interest on the loan as long as it is done under the gift tax laws.

The LLC must be treated as a separate business entity. Accordingly, a separate bank account must be established for the LLC and the parents would have to pay fair market value rent to continue to use the property.

Over time Mom and Dad could make partial sales or grants of their LLC interest or shares to the children, so they would have a minority interest in the property at the time of their subsequent deaths. As they sold an interest in the LLC (as opposed to interest in the underlying property), they would be able to discount the $3 million property value by as much as 20 percent. And let us say they made improvements in the property and increased its market value to $5 million. The bottom line in this scenario is that this family’s tax savings could exceed $2 million on the $5 million value of the home.

To meet challenge number two for this family of five and to create a separate nest egg for the grandchildren, a multigenerational irrevocable life insurance trust (ILIT) would acquire an $11 million life insurance policy on the mom by borrowing a certain amount a year from her dynasty trust. When the mom passes, an $11 million net death benefit would be paid to the ILIT. Any death benefit remaining, after repayment of the loan to the dynasty trust, would be held in the ILIT and eventually pass to the grandchildren tax free.

So, the proverbial bottom line in this scenario is that the plan saved just over $2 million in taxes by not gifting the house outright and it created a tax-free benefit to the grandchildren—all for the cost of some minor legal expenses.

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Bill Loftus

Bill is one of four founding partners of Coastal Bridge Advisors.   Bill leads the Corporate Executive Services, Lending and Alternative Investment operations of the firm. Bill is also responsible for overseeing new business development and the management of the firms west coast operation. With a career spanning almost 30 years, Bill began his career at …

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Coastal Bridge Advisors has been named the Best Private Wealth Manager Under $5B by Private Asset Management

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