Breaking up is hard to do and that is the case with so many couples. Sometimes, even after divorce, ex-husband makes a loan to his wife in order to purchase a new home.
In such cases, sometimes the use of the intra-family loan to manage divorce is quite helping while navigating the divorce proceeding. In case there is yet not the divorce settlement then the husband might need to be much careful about the unintended gifts to the soon to be ex-wife.
The loan that is properly structured might be a strong tool for maintaining the control over the use of proceeds. This might also be one way to just fund the marital dissolution or some business transaction.
In husband’s case, it might be that to help his ex-wife in buying the house by the use of loan actually maintains some clarity while a divorce proceeding is going on. In this world of the tax planning, the intra-family or just below the market loans are common to assist the family members to purchase their home or to give liquidity in the estate planning. Although before going through this path, this is a key to just understand every risk involved in intra-family loans to manage divorce.
The Basics of Below-Market Loans
Regardless of a reason for the below-market loan, this should always be dependent on the good faith. In husband’s case, he might be just trying to keep the family in their own home.
While structuring for the loan, fundamental loan requirements should meet to make it sure that a loan isn’t seen as some kind of gift. IRS would look at so many factors that include whether there’s written signed loan agreement along with some fixed amount of repayment schedule and some stated rate of interest.
Furthermore, a loan holder should report these payments on the tax return. When in an event the loan’s secured against the real property then the payer might deduct this as a mortgage interest rate up to a legal limit.
An emphasis on the correct documentation as well as structure is very crucial and must be done with the help of CPA and an attorney. If such aspects of a transaction aren’t addressed in a proper way then some intended lender could easily find himself with the non-collectable debt.
Furthermore, setting a rate of interest is not some kind of random decision. Below market in a context of the tax means that a rate of interest below some statutory rate called Applicable Federal Rate. Historically, the AFR has already been even less than the commercial rates (recently less than 3 percent). It is quite easy to just have a loan which is below market but isn’t below market legally.
Rates of the AFR are released on monthly basis by the IRS. They’re based upon whether a loan is of short-term (three years or even less), mid-term (three to nine years) or long-term (more than nine years).
In the above-mentioned case, it sounds that these requirements are easily met if the husband’s charging his ex-wife interest and also requiring some payment plan.
For the high net worth people like some rich couples, the loan that is not structured correctly might hurt them a lot. According to the taxpayers, in case both parties are not aware of these problems and thus structure their loan with the rate lower than the AFR then there might be some unwanted consequences for a lender. They might include the imputed income as well as gifts for the Federal tax purposes.
A Helpful Tool
A below-market loan that is between the family members may be just something that we consider do not in the divorce situations. For example, in some highly inflated markets of real estate in the U.S., grandparents as well as parents may use the below-market loans in order to assist their children to get into such market where otherwise can be much challenging. Also, they might be just used within the family for providing using private lenders versus student loan help.
An intra-family loan is a quite valuable way in order to help the family members financially. Hence, the intra-family loans to manage divorce might prove to be helpful.