Taking out a family loan? Be mindful of the tax ramifications

If you have ever floated the idea of helping a sibling launch a small business or nudged your kid toward a first flat, you already know the vibe. Banks feel slow, rates feel heavy, and your cash is sitting in a low-effort account. A private loan inside the family can look like the ultimate cheat code. Lower cost, fewer hoops, faster decisions. That is real. What is also real is the paper trail that HMRC expects, the way interest shows up on your tax return, and the inheritance tax consequences if the loan drifts into gift territory. None of this needs to be scary. You just need to treat a family loan like a real loan, not a handshake that hopes for the best.

Start with the only question that matters. Can you afford to be repaid late, repaid in stages, or in the worst case, not repaid at all. If the honest answer is no, then a loan is not the right tool. Family finance gets messy when someone silently expects gift energy while the other person silently expects bank energy. Make the expectations explicit. Talk about purpose, timeline, and boundaries before a single pound moves. If what your loved one truly wants is a gift, call it a gift and accept the tax and relationship implications with eyes open. If it is a loan, document it and run it like one.

Interest is optional. Many family loans are interest free by design, and that can be fine. If you do charge interest, the payments you receive are taxable income and belong on your self assessment return. That is not a reason to avoid interest altogether. In a high rate world, modest interest can be a fair exchange for access to capital, and it nudges the borrower to treat repayment like a priority rather than a soft promise. Think of interest as the price of flexibility. If your cash would otherwise sit in a deposit account, a well structured loan may deliver a better after tax return while still giving your family member more breathing room than a commercial lender.

For the borrower, interest can sometimes be tax efficient if the loan funds a qualifying purpose. Three common use cases show up in real life. Buying shares in, or lending to, a close company that they work in or control. Lending to a partnership in which they are a partner. Purchasing a rental property, where relief for residential interest is now capped at the basic rate rather than fully deductible from rental income. These rules are precise rather than vibes based, so the borrower should get tailored advice before assuming the relief will apply. Done correctly, your loan’s interest can be a cost of doing business for them and a modest income stream for you, all within the rules.

Documentation is not a nice to have. It is the backbone of clarity. A simple written agreement can be short and human readable while still covering the essentials. Record the names of the parties, the amount advanced, the date funds move, the interest rate if any, the repayment schedule, whether extra repayments are allowed, and what happens if payments are missed. If you want the loan to be recallable, say so clearly. Repayable on demand sounds harsh in a family context, but it protects the lender’s estate for inheritance tax and signals that this is a real debt, not an open ended transfer of wealth. It also gives both sides a practical lever if circumstances change.

For larger amounts or where property is involved, step up the formalities. A solicitor drafted agreement costs money, but it can save a lot more if something breaks later. If you want security, such as a legal charge over a property the borrower is buying, get specific legal advice about how to register that charge and how it interacts with any mortgage lender. Security is not only about repayment. It can also guard against value leaking out of the family if the borrower separates from a partner and the asset is split in a settlement. These are awkward conversations to start. They are much more awkward to avoid and then fight about.

Relationships matter more than rates, which is why structure protects both. Build in small, predictable repayment behaviors that keep momentum visible. Set the first repayment date, even if it is symbolic, and make sure the borrower has a simple way to pay you without friction. If cash flow is lumpy, agree to a minimum plus an optional top up when income allows. If the loan funds an investment that will not generate cash for a while, accept reality but tie repayments to milestones. The worst loans drift because no one knows when action is due. The best loans feel like a clear plan that everyone can follow.

Now the part that quietly trips people up. Inheritance tax. From an IHT perspective, a loan that is repayable on demand keeps its full value inside the lender’s estate. That sounds unhelpful until you consider the alternative. If you make what looks like a never never loan, HMRC may treat it as a transfer of value, which could trigger lifetime transfer rules you did not intend. Keeping the loan real, enforceable, and recallable does two things. It preserves the value in your estate for IHT calculations, and it avoids the argument that you gave something away when you meant to lend it. The borrower benefits from any growth they create with your funds, which sits outside your estate. Your estate recognises the original loan amount as an asset due back.

Forgiving the loan flips the tax story. The day you formally waive the debt is the day you make a gift. That gift is a potentially exempt transfer. Survive seven years and it falls out of your estate for IHT. If you die within seven years, it is pulled back in, potentially with taper relief depending on timing. The original date of the loan does not matter for this clock. The waiver date does. If you plan to forgive, document the waiver cleanly and understand the timeline that starts that day. Informal drifting into forgiveness creates confusion for both tax and family expectations.

What if the borrower dies while the loan is still outstanding. In that case, the debt usually reduces the value of their estate for IHT, which feels straightforward until it is not. Since mid 2013, restrictions limit the deduction of certain liabilities. If the borrowed funds were used to acquire excluded property, to park cash in foreign currency accounts that are left out of account, or to buy assets that benefit from business, agricultural, or woodlands relief, the deduction may be denied or reduced. There is also a practical requirement that the liability is actually discharged from the estate on death unless there is a real commercial reason it remains unpaid and the point of not repaying is not to gain a tax advantage. Translation. Paper trails and purpose matter. The executor should be ready to show what the loan funded, how it was used, and how it will be settled.

Sometimes the lender is not a person but a family trust. Trustees can lend to beneficiaries if the trust deed gives them that power, and modern deeds usually do. Loans from trusts can be interest free, but trustees should think like stewards of all beneficiaries, not just the one receiving funds. If a capital asset of the trust morphs into an irrecoverable IOU, that harms everyone else in line. The good news is that making a loan does not remove value from the trust for IHT. The receivable sits on the trust’s balance sheet. To keep that position clean, trustees should make loans repayable on demand and document them like any other third party loan. If a waiver later converts the loan into an outright appointment of capital, that is when IHT events for the trust may be triggered, so the tax analysis changes at that moment.

Rates have reset the vibe of family finance. During near zero years, gifting felt easy and opportunity cost felt minimal. In a higher rate world, the value of flexibility has gone up and the cost of fuzzy agreements has gone up with it. A crisp two page agreement protects the relationship because it eliminates silent assumptions. Charging modest interest can be the fair middle path between gift and bank, especially when the borrower can claim relief for a qualifying purpose. Keeping loans recallable on demand aligns with inheritance tax logic and preserves control if circumstances change. None of this makes a family loan cold. It makes it durable.

If you are the lender, run a simple stress test on your own finances before you say yes. Assume the worst case where repayment takes longer than planned or requires restructuring. Are your own emergency reserves intact. Are your retirement contributions unaffected. Will this loan force you to sell assets at a bad time if you need liquidity. If any of those answers make you uneasy, shrink the loan or restructure it rather than forcing courage. Generosity is not generous if it destabilises you.

If you are the borrower, treat your family lender like your most important creditor because they probably are. Share a one page plan that shows how the funds will be used, when cash begins to flow back, and what your contingency looks like if a milestone slips. Send regular updates without being asked so the lender never has to chase you for information. Silence breeds anxiety. Transparency builds trust and keeps the door open for future help if you ever need it again.

A quick word on tone. You can be friendly and precise at the same time. Use plain language in the agreement. Use exact numbers. Avoid legalese unless you are doing a secured charge, in which case let the lawyer write the parts that must be technical. The goal is not to impress a judge. The goal is to create a shared understanding that anyone in the family could read a year from now and still know exactly what was agreed.

It is also worth being explicit about early repayment. Most borrowers want the option to pay down faster once income improves or a sale completes. Most lenders welcome that because it reduces risk and returns liquidity. Say clearly that early repayment is allowed without penalty and describe how interest is handled in that case. If your loan is interest free, great. If it carries interest, spell out whether interest is calculated daily or monthly and how part month payments are treated. Ambiguity is the enemy of goodwill.

When you have the chance, keep the admin simple. Use bank transfers so every payment leaves a clean trail. Label each payment with a consistent reference so it is easy to match to the loan account. If you keep a spreadsheet, save it in a shared folder so both sides can see balances and dates whenever they want. If you prefer an app, pick one you will both actually open and keep up to date. You are not building a fintech here. You are building trust that can be checked in sixty seconds.

One last nuance, and it matters. Keep your estate plan and your family loan talking to each other. If you die with an outstanding loan to a child or sibling, your will should say whether that debt is forgiven, offset against their share of the estate, or collected in the normal way. If you do nothing, your executors have to make tough calls at a sensitive time. Five minutes of clarity today prevents five months of confusion later.

This entire conversation sits under a bigger umbrella. Family finance works best when you separate love from liquidity. The love part is why you want to help. The liquidity part is how you help without breaking your own future. Structure is not a lack of love. Structure is what keeps love from absorbing damage when money gets real. In a world of higher rates and sharper household budgets, that has never been more true.

If you remember nothing else, remember this simple sequence. Decide whether a gift or a loan fits the real need. If it is a loan, write it down, keep it recallable, and make repayment friction free. Charge interest only if you both understand the tax and the purpose. Keep the paperwork in one place, keep the communication regular, and keep your own plan safe. Do that, and family loans stop feeling risky and start feeling like exactly what they should be. A smart way to open doors for the people you love, while staying fully inside the rules and fully in control.

In the end, family money is about alignment. Align the purpose with the tool. Align the tax with the paperwork. Align the repayment with real life. Do that, and you will navigate family loans UK tax with a cool head and a clean conscience, which is the best kind of finance there is.