Family Loans: Tax Considerations When Lending Money to a Family Member

By Ginny Graef, CPA, Partner

Family Loans: Tax Considerations When Lending Money to a Family Member

By Ginny Graef, Tax Senior Manager, Family, Executive & Entrepreneur Advisory Services Team

Five Tips to Avoid Negative Tax Implications When Lending Money to Family

Due to the COVID-19 pandemic and resulting economic downturn, you may have family members that have encountered financial difficulties. If someone in your family needs financial help, you may be inclined to offer an intrafamily loan. Your kind gesture may open the door to unexpected taxable income, gift tax, or both. To help avoid these negative tax consequences, consider taking the following steps before lending money.

1. Keep records of the intrafamily loan.
You will want to show that the loan is legitimate. The following intrafamily loan information should be documented for tax purposes.

    • The amount and terms of the debt,
    • Interest charged,
    • Fixed repayment schedules,
    • Collateral,
    • Demands for repayment
    • Borrower’s solvency at the time of the loan, and
    • Loan payments received

Keeping accurate records, will also help to avoid loan-related misunderstandings between you and the borrower.

2. Demonstrate an intention to collect on the loan.
Even if you think you may eventually forgive the loan, ensure the borrower makes at least a few payments. By having some repayment history, you’ll make it harder for the IRS to argue that the loan was really an outright gift.

3. Charge interest if the family loan exceeds $10,000.
If you lend more than 10,000 dollars to a relative, charge at least the applicable federal interest rate (AFR). Be aware that interest on the loan will be taxable income to you. If no or below-AFR interest is charged, taxable interest is calculated under the complicated below-market-rate loan rules. In addition, all of the forgone interest over the term of the loan may have to be treated as a gift in the year the loan is made. This will increase your chances of having to use some of your lifetime exemption.

4. Use the annual gift tax exclusion.
If you want to, say, help your daughter buy a house but do not want to use up any of your lifetime gift and estate tax exemption, you can make the loan and charge interest and then forgive the interest, the principal payments or both each year under the annual gift tax exclusion. For 2020, you can forgive up to 15,000 dollars per borrower (30,000 dollars if your spouse joins in the gift) without paying gift taxes or using any of your lifetime exemption. But you will still have interest income in the year of forgiveness.

5. Forgive or file suit for default on a family loan.
If the family loan that you intended to collect goes into default, make the determination to forgive or file suit promptly. To prove this was a legitimate loan that soured, you will need to take appropriate legal steps toward collection. If you know you will never collect and do not want to file suit, begin forgiving the loan using the annual gift tax exclusion, if possible.

Source: Thomson Reuters

Questions on how you should approach family loans for your unique tax situation? Contact your Opportunity Advisor or Email | Call: 804.747.0000.

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About the Author

Ginny Graef

Ginny Graef, CPA, Partner

Ginny enjoys working closely with her clients and their team of legal and financial advisors to provide tax planning solutions that meet her clients’ specific needs and goals. Ginny’s areas of expertise include income, gift, and trust and estate compliance and planning services. In addition, she focuses on compliance and consulting related to investment partnerships.

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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.


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