Lending Money Without Tax Blows

While loaning money to a family member is a nice sentiment, it is important to ensure that the loan is made the tax-smart way.  Below are considerations to keep in mind:

• Charge IRS Interest Rate.  If you do not charge interest when loaning money, you could face unfavorable tax rules.  Yet, these can be avoided if you charge an interest rate that equals the IRS-approved applicable federal rate (AFR). 
• Put a Strategy in Action.  For example, if you want to lend $50,000 to your daughter so that she may buy a home, you could make a nine-year term loan with balloon repayment at the first end and charge the mid-term AFR, which is currently only 1.53%.  Your daughter can pay that same low rate for the entire nine years.  If you rather make a 20-year loan, just charge interest equal to the long-term AFR, which is currently only 2.30%.  You must include the interest income on your tax return and your daughter can deduct the interest as home mortgage as long as you secure the loan with her home.
• Devil is in the Details.  Put the loan in writing to ensure the IRS and the borrower will respect the deal as a loan instead of a gift.  This shows you are serious about getting your money back.

See Bill Bischoff, How to Lend Money to a Relative Without Getting Whacked by the IRS, Market Watch, May 12, 2015.

Special thanks to Jim Hillhouse for bringing this article to my attention.