How Can Parents Loan Money to Their Children to Buy a House?

 

Structuring Intra-Family Home Loans to Reduce Tax, Legal, and Relationship Risk

 

By Timothy Burke, National Family Mortgage ®
For informational purposes only; not tax or legal advice.

 

Executive Summary

Parents frequently help adult children buy a home by lending money directly rather than relying on traditional mortgage financing. When structured properly, a parent-to-child home loan can preserve family wealth, reduce borrowing costs, and provide flexibility unavailable through institutional lenders.

From a federal tax perspective, however, these transactions require careful attention. Informal or undocumented arrangements may be recharacterized as gifts, below-market loans may trigger imputed-interest rules, and poorly documented mortgages may fail to qualify for intended tax treatment.

This article explains how parents can loan money to their children to buy a house in a way that aligns with federal tax rules, establishes bona fide debt, and reduces the risk of unintended tax and family consequences.

 

Why Parent-to-Child Home Loans Require Structure

Family home loans sit at the intersection of personal relationships and formal financial rules. While parents and children may share mutual trust, tax authorities evaluate these transactions based on objective evidence, not intent alone.

Common problem areas include:

  • No written loan agreement

  • No stated interest, or interest below required levels

  • Unclear repayment expectations

  • Failure to document the loan as secured debt

  • Informal forgiveness or inconsistent enforcement

When these factors are present, the IRS may treat the advance as a gift rather than a loan, regardless of how the family describes it.

 

The Core Requirement: Bona Fide Debt

To be respected as a loan, a parent-to-child advance must reflect the substance of real debt.

Key characteristics of a bona fide family mortgage

A parent loan used to purchase a home is more likely to be respected when it includes:

  • A written promissory note stating:

    • Principal amount

    • Interest rate

    • Repayment schedule

    • Maturity date

  • Stated interest at an adequate rate, commonly evaluated using Applicable Federal Rates (AFRs)

  • Evidence of repayment, such as regular payments and payment records

  • Conduct consistent with enforcement, even when parents choose flexibility

No single element is determinative. Courts and the IRS evaluate the overall facts and circumstances.

These same principles apply more broadly to family lending and are discussed in greater detail in the context of lending to relatives generally.

 

Interest Rates and Applicable Federal Rates (AFRs)

Why interest matters

Charging interest is not optional for tax purposes. Loans that charge no interest–or interest below required benchmarks–may trigger the below-market loan and imputed interest rules, even if parents do not intend to receive interest payments.

Applicable Federal Rates (AFRs)

Applicable Federal Rates (“AFRs”) are the minimum interest rates published monthly by the Internal Revenue Service and referenced in the tax code as benchmarks for evaluating whether stated loan interest is adequate.

Using an AFR-based interest rate is a common method for aligning a parent-to-child home loan with federal expectations and reducing the risk of imputed-interest and gift-characterization issues.

 

Securing the Loan With the Home

When parents lend money for a home purchase, the loan is often intended to function as a mortgage rather than as unsecured debt.

Why securing the loan matters

A loan does not have to be secured to exist. However, when the loan is intended to operate as a mortgage–and when mortgage-interest treatment is relevant–properly executed and recorded lien documentation is typically required.

Recording a mortgage, deed of trust, or security deed:

  • Reinforces the existence of bona fide debt

  • Establishes creditor priority

  • Aligns the loan with conventional mortgage practices

  • Reduces ambiguity if circumstances change

Failing to record a lien may not invalidate the loan, but it increases legal and tax uncertainty.

 

Down Payments, Closing, and Practical Mechanics

Parent-to-child loans can be structured in several ways at closing, including:

Regardless of structure, documentation should clearly reflect:

  • When funds are advanced

  • How the loan is repaid

  • How the loan is secured, if applicable

Consistency between closing documents and loan documentation is critical.

 

Flexibility, Modifications, and Later Changes

Parents often want flexibility if a child experiences financial difficulty. Flexibility is not inconsistent with a bona fide loan, but it must be handled carefully.

Important distinctions include:

  • Temporary forbearance vs. permanent forgiveness

  • Amending loan terms vs. replacing the loan entirely

  • Documenting changes when interest rates or payments change

Forgiving debt generally constitutes a transfer of value at the time forgiveness occurs, not at loan inception.

 

Judicial Perspective: Expectation and Enforcement

Courts evaluating parent-to-child loans consistently focus on:

  1. Whether there was a realistic expectation of repayment, and

  2. Whether there was an intent to enforce repayment

These principles appear repeatedly in tax court decisions analyzing whether family advances constitute loans or gifts. Labels alone are not controlling; documentation and conduct matter.

 

Frequently Asked Questions

Can parents loan money to a child without charging interest?
A loan can exist without stated interest, but charging no or below-market interest may trigger imputed-interest and gift consequences under federal tax rules.

Does the loan need to be recorded as a mortgage?
Recording a lien is generally required for the loan to function as a mortgage and for certain tax treatments to apply.

Can parents later forgive the loan?
Yes, but loan forgiveness is generally treated as a transfer of value at the time forgiveness occurs and may have gift-tax implications.

Can parents make the loan flexible if the child struggles financially?
Flexibility is possible, but changes should be documented to preserve the loan’s treatment as bona fide debt.

Is a family loan safer than gifting money for a home?
Loans and gifts serve different purposes. Loans preserve repayment expectations; gifts transfer wealth outright. Each has different tax and planning consequences.

 

Common Misunderstandings

“Because it’s family, formal documentation isn’t necessary.”
Family transactions are often scrutinized more closely, not less.

“If payments are informal, it’s still clearly a loan.”
Inconsistent repayment behavior undermines loan treatment.

“We can decide later whether it was a loan or a gift.”
Classification depends on facts and intent at the time funds are advanced.

 

Technical Appendix

Key concepts
Bona fide debt
AFR-based interest rates
Below-market loans and imputed interest
Secured vs. unsecured family mortgages
Debt forgiveness as a transfer of value

Analytical framework
Expectation of repayment
Intent to enforce repayment

 

About the Author

Timothy Burke is the founder of National Family Mortgage ®, an online company focused on helping families document and support compliant intra-family mortgage loans and seller-financed home transactions. His work focuses on proper documentation, alignment with applicable federal tax rules, and practical implementation considerations for families and their professional advisors navigating private family financing.

Families and their advisors should consult applicable statutes, regulations, case law, and professional guidance when applying these principles to specific transactions.

 

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