If you offer a family member an interest-free loan, there could be a problem. Intra family loans (the term for loans among related family) are subject to IRS scrutiny, particularly if the sum is large.
The IRS assumes that all loans carry a certain interest rate. Intra family loans are no exception. Of course you can still give a gift of money to a family member, up to the taxation limits set by the IRS as ‘gifts”.
The IRS sets the “Applicable Federal Rate” (AFR) for loans. It is the interest you should have charged if a loan is not to be considered a gift.
The good news…The Applicable Federal Rate (published monthly at irs.gov) is the lowest it has been in a long time. As an example, in June 2020 the short term AFR is .18% annual, mid term loans AFR are .43% annual and long term loans AFR are 1.01% annual. The IRS publishes a Table with explanations. The AFR changes monthly.
Thus, if you want to loan a family member a large sum e.g. $100,000 to pay off a mortgage, then depending on the term of the loan the AFR would be in the range of 1%.
If you are considering the offer of an intra family loan, now might be a good time because of the existing low AFR.
Keep good records on any intra family loans, if the IRS decides to ask questions about the terms of any loans.
As always, with any financial transactions…Make sure the terms of the loan are in writing (even if the loan is between family members.)
If you have questions, consult a financial professional.
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