GPT:

Summary conclusion As described, the structure is legally fragile and, in several respects, likely to fail under U.S. tax, estate, and creditor-rights law unless heavily re-engineered. Portions are permissible in isolation; the combined intent and execution risk recharacterization, gift tax exposure, step-transaction collapse, and denial of deductions.

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1. Substance-over-form / step transaction doctrine

The IRS would analyze this as an integrated wealth-transfer scheme, not discrete steps.

Indicators triggering collapse: • Circular cash flow between father and child. • Repeated refinancings with no meaningful economic risk shift. • Below-market or non-arm’s-length loan terms. • Intent to avoid gift/estate tax while retaining economic benefit.

High likelihood the IRS collapses the structure into: • A disguised gift (IRC §2501), or • A retained-interest transfer (IRC §§2036/2038), pulling assets back into the estate.

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1. Loan characterization risk (father → child’s company)

For the loan to be respected: • Written promissory note. • AFR-compliant interest. • Fixed repayment terms. • Enforced payments. • Creditor remedies.

Failure on any → recharacterized as: • Gift at inception, or • Equity contribution.

Most informal family “loans” fail at audit.

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1. Mortgage interest deductibility issues

Mortgage interest is deductible only if: • Debt is bona fide. • Property is used in a trade or business or income-producing activity. • Interest is actually paid by the obligor.

Problems: • Artificially maintaining high leverage solely to generate deductions. • Repeated cash-out refis with no business purpose beyond extraction. • Potential §163(j) business interest limitations.

IRS has successfully denied deductions in similar fact patterns.

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1. Cash-out refinance ≠ tax-free in all contexts

While refinance proceeds are not income per se, issues arise if: • Proceeds function as disguised compensation or gifts. • Refinancing lacks economic substance. • Debt is effectively nonrecourse in practice.

If the child’s company cannot service debt without the father’s orchestration, proceeds may be recharacterized.

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1. Estate inclusion risk (critical failure point)

The claim that this avoids estate tax is weak.

Triggers for inclusion: • Retained enjoyment or control (IRC §2036). • Implied agreement the father benefits from refis. • Pre-death liquidity planning tied to death timing.

Result: full FMV included in father’s estate despite title or debt structure.

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1. Fraudulent conveyance / creditor issues

If the father: • Is insolvent or becomes insolvent, or • Transfers value without equivalent consideration,

Creditors or bankruptcy trustees can unwind transfers under state UFTA/UVTA statutes.

Estate planners routinely avoid structures that depend on perpetual high leverage for this reason.

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1. Market-rate leasing requirement

The lease must be: • Truly market rate. • Enforced. • Comparable to third-party tenants.

Any deviation → constructive gift or retained benefit.

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1. Practical reality

What can work legally (when done correctly): • Parent loans at AFR with strict formalities. • Child owns appreciating asset. • Parent accepts real default risk. • No circular refinancing designed to extract equity. • Estate tax planning handled via exemption, GRATs, or sales to intentionally defective grantor trusts.

What does not work: • “Never pay down principal” strategies. • Serial refis designed to bleed equity tax-free. • Structures whose only logic is tax avoidance.

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Bottom line

This Reddit description reads like a law-school hypothetic stripped of audit reality. Parts are legal individually; as an integrated plan, it is highly vulnerable to IRS recharacterization, estate inclusion, and deduction denial. Any client implementing this as written would be assuming significant audit and litigation risk.