Personal Finance: Ask the Experts

Get advice on money matters from The Bee's Claudia Buck and a panel of local experts

July 24, 2012
How best to handle loans between family members

Q: I have a rental property valued at $265,000, the mortgage balance is $151,000 at 5.75%. I'm considering a loan to pay off this balance from my father's living trust account, which is in excess of $400,000. I am the sole heir and these funds are just sitting in money market accounts making .25%! I would set up documents for the loan for tax purposes pay the monthly interest to my father's account at 2.00% with a 5-year payback schedule. If my father passed, how would these funds $151,000 which would be outside the trust be viewed by the IRS? Is there an amount of money that can be outside the trust without being subject to probate or tax? - Walt, Sacramento, CA

A: A loan from a family member can benefit both parties. It is important that the loan documents are prepared properly to avoid potential problems including misunderstandings and possible adverse tax consequences. The interest rate on the loan must be set at or above the Applicable Federal Rate (AFR) in order to avoid gift tax issues. The IRS releases current AFRs each month, and the rate varies for short-, mid-, and long-term loans. The July 2012 AFR rate for a 5 year loan is .92% per year.

In your situation, your father could loan you funds from his living trust. The loan should be documented with a promissory note and, if your father wanted collateral, with a deed of trust on your rental property. So that the IRS won't characterize the loan as a gift, you will need to make timely payments to the trust, and your father should document his receipt of the payments. Your father would have to pay income tax on the interest that he receives. If your father died before the loan was fully repaid, the note would be distributed as part of the trust estate. If you are the only beneficiary, you would receive the note as part of your inheritance and the remaining debt would be extinguished.

In California, probate is not required for estates valued at less than $150,000. The $150,000 threshold amount excludes assets held in trust, payable-on-death accounts, transfer-on-death accounts, and certain other assets, but it would include an outstanding note. Thus, if the note is not held in the trust and your father died before the note was fully repaid, a probate would be required for your father's estate if the remaining unpaid balance of the note caused his probate estate to exceed the $150,000 limit.

I recommend that your father work with an experienced tax or estate planning attorney to prepare the proper documentation for this intra-family loan.

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Meet Our Financial Experts

Claudia Buck

Claudia Buck is The Sacramento Bee's personal finance columnist. Read all her columns here. Contact her at

Terri Carpenter

Terri Carpenter offers advice on job hunting, retraining and career counseling. Carpenter works at Sacramento Works Inc., the career and job training arm of the Sacramento Employment and Training Agency (SETA). With 15 years in the field, she has hands-on experience with everyone from first-time job seekers to career professionals seeking advice after a layoff or looking for a mid-career change. Ask her a question.

Carlena Tapella

Carlena Tapella is a partner in the law firm of Webb & Tapella Law Corp. in Sacramento. The firm specializes in estate planning and probate, such as estates, trusts, conservatorships and litigation. She is a past president of the Sacramento County Bar Association's Estate Planning & Probate Section. Ask her a question.

Kimberly Foss

Kimberly Foss, certified financial planner, is the founder of Empyrion Wealth Management in Roseville. With nearly 30 years in the financial industry, her clients include women in transition, small business owners, retirees and "pre-retirees." Ask her a question.

Jesse Weller

Gregory Burke, a CPA and tax expert with John Waddell & Co. in Sacramento since 1984, worked as an IRS tax auditor for six years. He’s a past chairman of the California Society of CPAs. Ask him a question.

Daniel Tahara

Daniel Tahara takes your questions about California taxes. Tahara, a spokesman for the state Franchise Tax Board, has 10 years of experience as a tax auditor. Ask him a question.

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