Leveraging Intrafamily Loans and Trusts for Generational Real Estate Wealth Transfer

The transfer of generational wealth to younger family members has always been a strategic challenge, particularly in real estate—a sector where high asset values and evolving tax rules complicate estate planning. As the IRS tightens regulations and tax rates rise, families must adopt innovative strategies to preserve equity, minimize liabilities, and ensure smooth intergenerational transitions. This article explores how intrafamily loans and co-ownership trusts can be structured to navigate these complexities while supporting homeownership across generations.

Intrafamily Loans: A Legal Framework for Tax Efficiency

The cornerstone of any wealth transfer strategy lies in compliance. Recent IRS rulings, such as Estate of Barbara Galli v. Comm'r, underscore the importance of structuring intrafamily loans properly. For instance, a $2.3 million loan to Galli's son, bearing interest at the Applicable Federal Rate (AFR) of 1.01%, was upheld as a valid loan precisely because it met IRS criteria: a written promissory note, timely interest payments, and a clear repayment schedule.

The AFR, which varies monthly based on loan terms (short-term, mid-term, or long-term), is critical to avoid recharacterization as a gift. As of July 2025, the mid-term AFR (for loans of 3–9 years) stands at 4.11%, while the long-term rate (over 9 years) is 4.79%. These rates are historically low, creating an opportune window to lock in favorable terms.

Actionable Strategy:
- Use the mid-term AFR for shorter-term loans (e.g., 5–8 years) to capitalize on lower rates.
- For long-term holdings, consider long-term loans to align with the property's appreciation timeline.

Co-Ownership Trusts: Balancing Control and Tax Benefits

Co-ownership trusts, such as Qualified Personal Residence Trusts (QPRTs) and Charitable Remainder Trusts (CRTs), offer dual advantages: transferring assets to heirs while reducing estate taxes.

• QPRTs: These allow families to gift a residence to heirs while retaining the right to live there for a set period. The gift's value is discounted, minimizing estate tax exposure. With the 2025 estate tax exemption projected to drop to pre-2018 levels, QPRTs become even more critical.
• CRTs: These enable families to transfer real estate to a CRT, which pays income to beneficiaries for a term (e.g., 20 years) before donating the remainder to charity. The Section 7520 rate (currently 5.00%) determines the charitable deduction's value. Higher rates benefit CRTs by increasing the deduction's present value, making them ideal for wealth transfer.

State Law Considerations:
California's Civil Code §1668 invalidates clauses limiting liability for intentional torts (e.g., willful damage to property). Co-ownership trusts must avoid such clauses to remain enforceable. Instead, rely on state-specific asset protection rules and clear ownership stipulations.

Mitigating Tax Risks Through Precision

Failure to adhere to IRS guidelines can lead to costly recharacterization of loans as gifts. In Estate of Bolles v. Comm'r, the IRS imposed gift taxes because the borrower defaulted on interest payments. Key compliance steps include:
1. Documentation: Draft a promissory note with the borrower's signature, repayment schedule, and interest rate.
2. Reporting: File IRS Form 709 if the loan's value exceeds annual gift tax exclusions ($18,000 per recipient in 2025).
3. Consistency: Ensure timely interest payments to avoid triggering penalties.

Investment Strategy for Generational Homeownership

1. Lock in Today's Rates: With AFRs at multiyear lows, establish intrafamily loans now to secure interest rates below market averages.
2. Use CRTs for Appreciated Assets: Transfer high-value real estate into CRTs to leverage the current Section 7520 rate, maximizing tax deductions while retaining income.
3. QPRTs for Primary Residences: Transfer the family home to a QPRT to reduce its estate tax footprint while retaining occupancy rights.

Conclusion

The combination of intrafamily loans and co-ownership trusts offers a robust framework for transferring real estate wealth across generations. By aligning with IRS regulations, leveraging low AFRs, and structuring trusts with state-specific compliance in mind, families can preserve equity, reduce tax burdens, and ensure that homes remain in the family for decades. In an era of tightening tax rules, proactive planning is not just advantageous—it's essential.

Investment Takeaway: Act now to capitalize on favorable rates and structures. Consult a tax attorney or estate planner to tailor these strategies to your family's needs.