Tax on Interest From family Loan?

You need to use the Applicable Federal Rate (AFR) in affect at the time of the loan if the loan amount is greater than $10,000. If $10K or less, you don't have to worry about imputed interest. The IRS publishes the list each month at:

are 4 compounding rates published for each term: Month;y, Quarterly, Semi-Annually and Annually. Short-term loans are defined as loans of 3 years or less. Mid-term loans are loans greater than 3 years and no more than 9 years. Long-term loans are greater than 9 years.

3.25% is greater than the current short and mid-term loan rates. However, it is below the current long-term rate. If your loan to your child is greater than $10K and for a period of time that exceeds 9 years, you would declare the interest received plus you would have to add imputed interest (the amount of interest computed by using the difference in the AFR and 3.25%). Interest income from a family member gets reported in the same manner you would report bank interest.

See the following article at the Motley Fool for more information on related party loans.

I have had a loan of this nature to my son now for about 10 years. The AFR at inception was considerably higher than it is now. IRenegotiated the loan and am now charging 4.00%. I report the interest as income but do not fill out a 1099 form that I send to the IRS. So far, the IRS has not complained to me.

One time, the IRS complained to my son about his taking the home interest deduction. But after he showed them his bank statements and the monthly statements I gave him every time he made a payment, they never bothered him again.

I use Excel to prepare the statements. The sheet gives the cumulative results within a calendar year. It starts out with the loan balance and interest rate. For each month, the payment is divided into interest, principle reduction and the new loan balance. At the end of the hear all cumulative amounts are also listed.

Why would you fill out a 1099? You are the recipient of interest income, not the payer of interest income.

Of course he is only allowed to deduct the interest if it is qualified mortgage interest. One requirement is that the loan be secured debt:

The mortgage must make ownership in the qualified property security for payment of the debt; provide that the home could satisfy the debt in case he defaults; and the loan must be recorded or "otherwise be perfected under any state or local law that applies".

If not secured, it is nondeductible personal interest.

I have a related question -- If the OP wanted to, could he charge his kid 0% interest on the loan and neither party would have to worry about reporting interest payments to the IRS?

The reason that I am asking is that I sometimes buy properties (real estate) as an investment, and I belong to a real estate investor association where presenters come and give talks on how to invest in real estate. Sometimes, the presenters talk about offering to buy properties from an owner for say $100,000 with the investor/buyer paying the owner $1,000 per month for 100 months (8 years and 4 months) -- with no interest involved.

I always thought that the IRS required some kind of imputed interest to be calculated on this type of arrangement, but the presenters say that it is perfectly legal to structure a deal this way. Is this correct? Can a deal be legally structured where an owner sells a property to an investor for say $100,000 and the investor/buyer pays $1,000 per month for 100 months with no interest?

He could charge less interest than determined by the IRS. But if he does, the interest that should have been charged is imputed, meaning it's counted as taxable income for the recipient.

In that case interest is imputed, which lowers the sale price for tax purposes, and converts the amount of interest that should have been charged to ordinary income to the recipient rather than capital gain.

It's certainly legal. There are tax consequences, though.

Yes, as stated above.

I am glad to find this out. There is no problem because I hold a first trust deed on the property.

Thanks for the reply. The loan will be greater than $10K but limited to

5 years so I should be okay using 3.25%

Thanks Stuart.

Would the buyer be able to claim less than $100,000 purchase price for property tax purposes, and impute interest payments for income tax purposes? It's obviously not a straight deal, as there is no such thing as zero interest.

Steve

For tax purposes the purchase price would be the amount paid less imputed interest. The amount of imputed interest will depend on the date of the purchase and the length of time payments are made.

In the example given, for a transaction entered into this month, imputed interest would be at the rate of 2.25%. Unfortunately I am unable to calculate the amount of imputed interest at this time. But it would entail getting the amortization schedule for a loan of 8 years and 4 months, fully amortized at $1,000 per month.

You report the interest you receive. If you elect to treat the equity debt as "not mortgage interest" you use tracing rules to determine the nature of the interest you pay. In this case the interest on the balance you loan to the kid is "investment interest" deductible on Schedule A (sometimes after calculating on Form 4952). Essentially it's almost a wash (save for adjustments if you have deductible medical or miscellaneous deductions).

Where do I report the interest I receive? Wouldn't that be on Schedule B, Part I? The kid uses the standard deduction so she is not concerned about deducting the interest paid to me.

The specific rules depend upon the amount of the loan.