Below-market loans must adhere to IRS regulations
There are tax planning opportunities that are available for many common family situations, and below-market loans made by family to family could be one of them.
The tax laws generally require that all loans must include a charge for a reasonable rate of interest. If no interest is charged on a loan (this is known as a “gift loan”) the IRS will impute interest income to the lender based upon published rate tables.
This imputed interest will be income to the lender even though the lender has not charged interest to the borrower.
There are two exceptions available for the lender to avoid this imputed interest:
– One is called a “de-minimus” exception. If a loan is under $10,000 no interest will be required to be charged.
– A second exception can be used for loans under $100,000. The lender is only required to report, as interest income, the amount of investment income generated by the borrower. A common situation may be that parents want to help their children purchase a home. For example, parents lend their daughter $95,000 for the down payment and do not want to charge interest. The daughter then generates $500 of interest and dividends that year from her own investments. In this situation the parents will report this $500 as interest income on the $95,000 loan.
But wait! There is a further exception: if the investment income generated by the daughter is under $1,000, then there is no reporting of income by the parents at all.
The primary purpose of the gift loan cannot be for tax avoidance. Otherwise this can provide opportunities for families and others to provide inexpensive financing to their family and friends.
If you have lent or borrowed money at a below-market rate from family or friends, make sure your ShindelRock tax professional knows about it and can account for the loan in your tax preparation.