Interest Free Loans

A loan from one family member to another without an interest rate. The obligation is for principal only.

IRC Section 7872 regulates interest free and below market rate interest loans.

Gift tax consequences

For a demand loan, the lender is treated as gifting the excess of the present value of the interest and principal payments (calculated using the AFR in effect at the time of the loan)over the actual amount of the loan each year on December 31st.

For a term loan, the lender is treated as gifting the excess of the present value of the interest and principal payments over the actual amount of the loan at the time of the gift.

Income tax consequences

The lender must include in his/her income the interest amount attributable for the year and the borrower may deduct the interest amount (in accordance with the provisions of IRC Section 163).

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