Family loans and gift tax

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  • #3152
    FamilyBurrower
    Participant

    We are interested in borrowing money from a family member as a bridge loan to buy a new house, and paying them back when we sell our old place.

    There are lots of online articles explaining how such a family loan must charge interest of at least the Applicable Federal Rate. Otherwise, the lack of interest is considered a gift, and is subject to gift tax.

    However, I understand a gift up to $15,000 per year is not taxable. At the current AFR of 2.52%, an interest-free loan could be huge without reaching $15k of imputed interest. And wouldn’t the amount be doubled if my spouse and I are the borrowers, since each person gets the $15k exclusion? Am I missing something here, or would most family loans never be big enough to incur such a tax?

    Are there any tax reporting requirements for imputed gift interest under $15k?

    Also, can such loan be unsecured, and just on paper in a drawer in the borrower and lender’s desks? Or does it have to be a mortgage secured by real estate, and recorded with the county, for the IRS to consider it legitimate?

    #3154
    Kaye Thomas
    Moderator

    The theory behind these rules is that the lender had a right to receive a minimum amount of interest on the loan, and should be treated as is (1) the lender received that interest and (2) made a gift of the same amount to the borrower. You’re focusing on the consequences of part 2, the gift. It’s part 1 that creates the problem: the lender has to report imputed interest income.

    If the loan is between natural persons (you aren’t borrowing from a business or a trust, for example) and the total amount borrowed is no more than $100,000, under a proposed reg, imputed interest is limited to the amount of the borrower’s investment income. The idea here is that the IRS doesn’t have to worry about these loans unless they’re being used to shift investment income from one person (usually someone in a high tax bracket) to someone else (usually in a lower one). So, if you and your spouse can get by with each borrowing no more than $100,000, and you have little or no investment income, you should be able to work this out.

    The loan doesn’t have to be secured. There’s a requirement for a loan to be secured if you’re looking to claim an itemized deduction for interest paid on the loan, but that’s obviously not an issue here.

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