Being Clear and Firm

You will need to decide upfront if your money is a gift or a loan. Especially when the money is changing hands in the context of a parent/child relationship, the parent needs to be crystal clear and firm about his or her expectations. This is critical not just for the sake of the relationship, but also to address tax implications.

If the money will be a gift, you need to write a letter stating that there is no expectation of repayment, and there are no strings attached. Remember that gifts up to $12,000 between two individuals are exempt from the gift tax, so up to $48,000 might be gifted from married parents to a child and spouse without tax implications(see 'Tax implications of private loans.') Having a record of your gift intention letter can also be crucial if you pass away and relatives have differing recollections on whether you expected repayment to your estate or not. Note: gift tax exemptions are annual and therefore a new gift letter must be written each year.

Many lenders prefer to structure intra-family money transfers as loans. If the money will be a loan, it needs to look, feel and act like a loan. In other words, it should be set up the way a bank would loan money to a stranger, with interest, a repayment schedule, legally binding documentation and professional servicing. The IRS will assume an intra-family transfer is a gift, unless there is hard evidence of a loan, set up to resemble a bank-like loan, with proper documentation and repayment (see 'Tax implications of private loans.')

This formal structure is necessary not just to convince the IRS that this is a loan, but also to protect the personal relationship. By establishing a lending relationship that is separate from the personal relationship, you increase the chance that the loan will be taken seriously and repaid.

In other words, don't hem and haw about whether repayment is required - either it is, or it isn't. BE CLEAR UP FRONT.

However, once the expectations have been set, one of the many benefits of private loans is that they are flexible. For example, a lender can for any reason, forgive one or more payments. The giver simply needs to send a letter before the due date notifying the borrower of his or her intention to forgive the upcoming specified payments. In this way, a lender can make significant gifts to a family member as part of a private loan.