Intra-Family Loans – Make Sure You Follow the Rules

Gift Tax

Loans among family members, especially from parents to children, are very common.  However, most people are not aware of the tax laws regarding such loans.  With certain exceptions, if you make an interest free to loan to a family member (or friend, for that matter), the IRS will impute the interest income to you, meaning that you are required to pay tax on a certain amount of interest, even though you never received it.  Here are the basics:

  • Loans of $10,000 or less.  No interest income will be imputed provided that the borrower does not use the money for income-producing investments.
  • Loans of $100,000 or less.  No imputed interest income provided that the borrower has less than $1,000 of total net investment income each year.
  • Other loans.  Make sure you charge (at least) the Applicable Federal Rate in place in the month during which the loan is made.  These rates, set by the government, change monthly and depend on the length of the loan [(1) up to 3 years, (2) 3 to 9 years, and (3) over 9 years)].
  • Promissory Note.  Make sure you properly document the loan, with interest rate, payment terms and length of loan.  Otherwise the IRS may treat it as a gift, which would require a filing a gift tax return and possible payment of gift tax.  It also can help avoid family disputes in the event of the death of one of the parties to the loan.
  • Deed of Trust/Mortgage.  To secure the payment of the loan by the borrower’s personal residence, the borrower can sign a deed of trust, which is then filed in the county Register of Deeds.  The borrower can then deduct the interest payments for income tax purposes.
  • See a Lawyer.  To ensure that you don’t run afoul of tax laws and otherwise protect yourself, consult with a tax lawyer, and have him or her prepare the necessary documents.
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