When it comes to supporting family members financially, clients often consider two primary options: gifting money outright or making a loan. Both approaches carry tax implications, so understanding the distinction between a gift and a loan is essential to comply with IRS rules and avoid unexpected tax consequences. Loans between family members – intrafamily – are commonly used to help with the purchase of a home, start a business, or pay down high-interest debt. They can also serve as another way of shifting wealth to the next generation. This article will touch on the important tax considerations to be mindful of before moving forward and lending funds to a loved one.

Before proceeding, please note that this article is for educational purposes only and should not be treated as legal or tax advice.  The information below is not a substitute for specific legal or tax advice from your own professional advisor.

What is an Intrafamily Loan?

A loan is a formal agreement where money is transferred from one party to another with the expectation of repayment with interest. This distinguishes it from a gift, which is given without any obligation or expectation of repayment.  So, when loans are made between family members, they need to be treated as a legitimate financial transaction to demonstrate a “bona-fide creditor-debtor relationship”, as the IRS generally assumes that transfers between family members are gifts.

To ensure the loan’s legitimacy, it is essential to document the loan with a formal, written agreement – a promissory note – with a clear repayment schedule, security or collateral, forgiveness terms, and an appropriate interest rate.  The interest rate of the loan must be at least equal to the Applicable Federal Rate (AFR), which the IRS publishes monthly and can be found here Applicable Federal Rates | Internal Revenue Service.

Once the proper loan agreement has been executed, records of payments should be maintained, as without proper documentation, the IRS has more reason to view the loan as a gift, leading to adverse tax consequences.

Income Tax Considerations

The core income tax issue with family loans revolves around the concept of “imputed interest.”  The IRS expects lenders to charge at least the appropriate AFR, even if they do not actually collect it.  If a lender charges below the AFR or no interest, the difference between the AFR and the actual interest charged is considered imputed interest, which must be reported as taxable income. Even if the interest is ultimately gifted to the borrower or forgiven, the lender is still liable for the income tax on that imputed interest.

However, there are a couple of exceptions when it comes to reporting imputed interest as income for the lender:

1. Loans of $10,000 or less, when not used for investments, are generally exempt from imputed interest rules, meaning no interest income has to be reported. (1)
2. Loans of $100,000 or less are generally exempt if the borrower’s net investment income* is $1,000 or less, i.e., if the borrower’s net investment income for the year is no more than $1,000, the lender’s taxable imputed interest income is zero. If the borrower’s net investment income exceeds $1,000, the lender’s taxable imputed interest is limited to the lesser of the borrower’s net investment income or the calculated imputed interest.^[1]

* In general, net investment income includes, but is not limited to: interest, dividends, capital gains, and rental income Net Investment Income Tax | Internal Revenue Service

Unless one qualifies for the above exemptions, lenders will need to charge the appropriate AFR rate for any intrafamily loan and report the interest as income.

Another important reason to document the loan is to be able to take advantage of possible income tax deductions.  For example:

• The borrower could potentially deduct the interest if the loan is used for specific purposes, such as a home purchase or starting a business.
• If the borrower cannot repay the loan, the lender may be able to take a capital loss to offset other capital gains realized, plus up to $3,000 of ordinary income.

Gift and Estate Tax Considerations

Intrafamily loans are not only impacted by income taxes, but they are also subject to gift and estate taxes if/when loans are forgiven.

Each year, a person can gift up to the annual exclusion amount and not have to file a gift tax return or reduce their lifetime gift and estate exemption amount.  In 2025, the annual exclusion amount is $19,000 per person per donee, and the lifetime gift and estate exemption amount is $13.99 million per person. These amounts are double for married couples.

When a loan is outright or partially forgiven, the forgiven amount is considered a gift.  If the amount forgiven (interest and/or principal) falls under the annual exclusion amount, there are no gift tax issues for that year.  But if the forgiven amount exceeds the annual exclusion amount, the lender will have to report the “taxable gift” on form 709, which will reduce their lifetime exemption amount.

As such, an intrafamily loan can serve as an effective wealth transfer tool when properly structured, as any gains the borrower accrues from investing the borrowed funds do not use up any of the lender’s lifetime gift and estate exemption.

Closing Thoughts

Intra-family loans can be a great way to provide financial support to loved ones while preserving family wealth. However, it’s essential to approach these arrangements thoughtfully to avoid misunderstandings or unintended tax consequences. Having a formal written agreement in place is critical to ensure the loan’s legitimacy as well as legal/financial protection for both parties. If you’re considering making a loan to a family member, we’d be happy to discuss your situation and determine the best way to help you achieve your goals.

^[1] U.S. Code 7872 – Treatment of loans with below-market interest rates (Link)

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