Lending to family members: How to avoid the pitfalls

What starts out with the best intentions can soon result in family disharmony. The tragedy is that this is so easy to avoid if you take some simple precautions from the outset.

The economic consequences of COVID-19 mean we will be relying on family to help us more than ever and that support is likely to take the form of ‘financial assistance’.  Lending to family members can be problematic – the danger being that either you won’t be repaid, or an important relationship will be spoilt.  To minimise the downside of inter-family loans and to help you to achieve what you want to do, i.e. provide temporary assistance to a loved family member, we have the following tips:

Gift or Loan?

What sort of help are you offering?

Is the financial assistance you are providing a gift or a loan?  A loan must be repaid.  A gift does not.  Have you made it clear what your intentions are?  “Let me help you out,” might mean ‘loan’ to you, and ‘gift’ to them.

You must put your intentions in writing, whether it be a gift or a loan, but especially if it is a loan.  To avoid a mismatch of intentions, the loan agreement should cover such things as the amount and purpose of the loan, how long the loan is going to be for, the lender’s entitlement to interest and whether there is any security being provided for the loan.  The loan terms should be realistic and capable of being enforced and adhered to.

Even if you are making a gift, it is still important to record this intention in writing. If you die and this is unclear, then chances are your beneficiaries will argue about what you have done. The person you gave the money will argue it is a gift, while your other beneficiaries will argue that it was a loan that needs to be repaid to the estate. We see this so often, and it is awful to see a family fighting over something that could easily have been cleared up from the outset.

Who are you lending the money to?

You need to know who you are lending the money to and for what purpose.

Are you lending money to your family member’s business or assisting them (and perhaps their spouse) to purchase their home?  In these situations, it’s very important that the loan is formally recorded.  Failure to do so could result in the financial assistance being classified as a gift and ‘gifted money’ can end up in unintended places, for example with a child’s creditors or ex-spouse and can be the source of discord where deceased estates are concerned.  For more on protecting a loan against a former in-law see this article.

Register the security

In Australia, you can register your security interest over non-land assets with the Personal Property Securities Register (PPSR).  If your child’s business becomes insolvent, as a secured creditor you have a priority ranking over unsecured creditors when the assets of the business are sold.  For more on the PPSR read this article.

If you have lent your child and their spouse money to purchase their home, then you are able to caveat your interest by registering a mortgage with the land titles registry of the State in which the property is located.  Please read this article to find out how we can assist you in protecting your security interest in real property.  By registering a mortgage over the property, you ensure that your loan will be repaid from the sale of the property.

What are some other considerations?

Are you receiving Centrelink support?

If you’re receiving Centrelink benefits such as the Age Pension, you will need to make them aware of any loan you make, even though it involves family.  A loan to family is still considered an ‘asset’ and Centrelink requires you to make this information available. Alternatively, if it is a gift then it will cease to be counted as an asset – BUT only after 5 years from when the gift is made. You should take this waiting period into account when working out the timing of your intended gifts.

What do you need to include in your tax returns?

If you’re receiving interest on your loan, the Tax Office needs to know about it, even though it’s coming from a family member.  As with other forms of income, this will be included in what’s considered your taxable income for the year. Of course, you don’t need to charge interest. But if you do not charge interest, then it is absolutely critical that you record the advance as a loan otherwise it will certainly be seen as a gift.

Is there any time limit on when a loan needs to be repaid?

Each State has a time limit in which a civil claim for the repayment of a debt can be made.  A demand made for a loan may be unenforceable if that time limit (6 years in S.A.) has expired since the date of the loan. You can re-fresh this time limit by sending the borrower a formal notice that you still expect the loan to be repaid.

How we can help you?

Lending money should be a financial rather than an emotional decision.  The bottom line is: can you afford to do it?  If you have decided to proceed, we can help you formalise your loan arrangements with your family members and register your security interests.  If you need to enforce a loan against a family member, we can help you as well.

On the other hand, if you intend on making a gift then we can help you record this intention in a formal Deed of Gift.

Call us on 1300 654 590 to get started.

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