Dear Client:

Here’s some information on how you can make loans to your family, or perhaps, help a family member buy a home by making a loan to them while ensuring that you and the family member benefit from a tax-smart loan structure.

Especially with home loans, the current national average interest rates for 30-year and 15-year fixed-rate mortgages is at 6.81 percent and 6.13 percent, respectively. Family loans can offer a much more attractive alternative. By charging the Applicable Federal Rate (AFR) as interest, you can give the borrower a good deal without giving yourself a tax headache.

The IRS issues new AFRs for term loans every month. The rates for April 2023 were as follows:

• Short-term loan (three years or less): 4.86 percent
• Mid-term loan (over three years but not more than nine years): 4.15 percent
• Long-term loan (over nine years): 4.02 percent

Charging at least the AFR for a term loan to a family member allows you to avoid federal income tax and federal gift tax complications.  If at some future point, if the AFR rates lower, you can always renew the loan with the lower rates.

There is also some ways to charge ZERO INTEREST on family loans. There are several tax-law exceptions:

1. First, it is possible to gift (not loan) $17,000 per year per person without any tax consequences. Additionally, if your son or daughter is married, you can give another $17,000 to the spouse (bringing the total to $34,000).
2. Second, it is possible to make family loans at $10,000 or lower without charging any interest. If a son or daughter is married, you could also loan $10,000 to their spouse for $10,000 or less without charging interest (bringing the total to $20,000). This could be done to give them a downpayment.

1. Third, there is also a $100,000 loophole, however there may be some complications. With the $100,000, you may have charge zero interest, but consideration should be given to possible tax implications. There may be imputed interest income to the maker of the loan if the total investment income of your son or daughter exceeds $1,000 in investment income (i.e. interest,  dividends, etc.) per year. There are also possible gift tax implications.

It is crucial to document the loan with a written promissory note. Additionally, if you are going to charge interest and the borrower wants to deduct home mortgage interest on their tax return, it is important to legally secure the home as collateral.  Make sure the borrower signs the note and that the note includes details such as the interest rate, a schedule of interest and principal payments, and any security or collateral for the loan. It is also possible to make some notes at the date of the loan documenting your intentions behind the loan (i.e. that you do expect repayment, and if interest is charged, that it will bear interest and you will receive earnings).

In conclusion, loans can assist family members in this crucial time when costs are rising so precipitously. They can provide homebuyers with better interest rates than commercial lenders offer, especially if family members charge the AFR. Remember to consider the loan terms and tax consequences when structuring the loan.

If you would like to discuss the family loan concept, please call us on our direct line at 505-232-3275.

Sincerely,

Southwest Accounting Pros, LLC