Be Tax Smart When Lending to Loved Onesby Tim Manni
Loaning money to a loved one has always had the potential of getting complicated. But if you’re in the position to do so, make sure you do it in a way that allows you to benefit as well. To avoid complicated tax laws, charge an “IRS-approved applicable federal rate (AFR)” on top of the loan.
* 0.72% for “short-term” loans of up to three years.
* 1.93% for “midterm” loans over three years, but not over nine years.
* 3.49% for “long-term” loans over nine years.
AFRs are updated monthly in response to ever-changing bond market conditions. Today’s super-low AFRs reflect the current super-low rate environment, which may not last much longer. AFRs for each month are published in Internal Revenue Bulletins and can be found at IRS.gov. With a term loan, the AFR on the month you make the loan applies for the entire term.
To avoid a loved one mis-interpreting your loan as a gift, make sure the entire agreement is put into writing. This will also guarantee the IRS respects your deal down the road.
Click here for additional information on AFRs.