The $100,000 Loophole.
With a larger below-market loan, the $100,000 loophole can save you from unwanted tax results. To qualify for this loophole, all outstanding loans between you and the borrower must aggregate to $100,000 or less.
If you lend more than $10,000 to a relative, charge at least the applicable federal interest rate (AFR) — and be aware that the interest will be taxable income to you.
There is no minimum interest rate you are required to charge, but you will be liable for taxes if you decide to give a below market interest loan to the IRS. This is because as a lender, you are expected to charge market interest and if you don't do so, you are in effect liable for the interest foregone on the loan.
The IRS requires intrafamily loans to have a written agreement that establishes a formal relationship between the lender and borrower. In addition, the family member lending the money must make sure the borrower can afford to repay the loan.
The IRS mandates that any loan between family members be made with a signed written agreement, a fixed repayment schedule, and a minimum interest rate. (The IRS publishes Applicable Federal Rates (AFRs) monthly.)
If you lend the money at no interest, the IRS can consider the loan a gift, making you liable for gift taxes.
If you lend money to a relative or friend with the understanding the relative or friend may not repay it, you must consider it as a gift and not as a loan, and you may not deduct it as a bad debt.
Loan agreements, promissory notes, and IOUs
The most basic loan agreement is commonly called an "IOU." These are typically used between friends or relatives for small amounts of money, and simply state the dollar amount that is owed. They do not usually say when payment is due, nor include any interest provisions.
In fact, you can loan money to a family member without charging any interest as long as the loan is less than $10,000. When the loan is $10,000 or more, the IRS requires that you charge a minimum interest rate called the applicable federal rate (AFR).
The IRS allows you to gift up to $18,000 in money or property to an individual each year without having to report it to the IRS (for the tax year 2024). Even if your gifts exceed $18,000, it's still unlikely you'd have to pay taxes unless you've surpassed the lifetime gift tax exclusion ($13.61 million in 2024).
You probably can't borrow money interest-free from a traditional lender, but you may be able to get a no-interest loan from: Retailers: Car dealerships and other retailers may offer 0% annual percentage rate (APR) financing for a set amount of time.
Gift tax limit 2024
The gift tax limit, also known as the gift tax exclusion, is $18,000 for 2024. This amount is the maximum you can give a single person without having to report it to the IRS. For married couples, the limit is $18,000 each, for a total of $36,000.
If someone else pays off your mortgage or another significant debt, it could be considered a gift under tax laws.
It can be difficult to establish whether a payment is a loan or a gift unless there is some sort of written acknowledgement/agreement in place. Even if a loan is to your friends or family, it is advisable to draw up some form of written agreement so that your intentions are clear.
Any interest you receive will be treated as income for tax purposes. For instance, if you loan a family member $45,000 for a year, and the applicable federal rate for that kind of loan is 4% and that's how much you charge, you'll receive approximately $1,800 in interest to report as income and pay any taxes due.
Consider the borrower's character and reputation.
If it's someone who you know has trouble managing their money, and you want to help them out, that's okay. Just be aware that they might not pay you back. If it's someone you're bailing out constantly, you may want to reconsider.
In situations where a loan is given without interest, and upon auditing, the IRS might either impute interest on the loan or classify it as a gift if it falls below the limit to that individual or entity. Of course, if interest is imputed, the failure to pay taxes on that interest will carry fines and penalties.
You don't have to worry about family loans being subject to federal tax consequences if: You lend a child $10,000 or less, and the child does not use the money for investments, such as stocks or bonds.
The primary way the IRS becomes aware of gifts is when you report them on form 709. You are required to report gifts to an individual over $17,000 on this form. This is how the IRS will generally become aware of a gift. However, form 709 is not the only way the IRS will know about a gift.
The family member or friend loaning the money must consider the chances of not getting it back and whether the loan will impact their own financial goals. Tax implications: If the family loan is interest-free and over a certain amount ($17,000 in 2023 or $18,000 in 2024), the lender may need to file a gift tax return.
A: The IRS defines an intrafamily loan as a formal creditor- debtor relationship involving an agreement, whereas gifts are given without obligations or expectations. When money is transferred with the expectation of repayment, it's a loan.
The two sides must sign a promissory note that spells out the interest rate, terms and conditions, length of repayment period, and ability to transfer the loan to another party.