Tax on Interest From family Loan?


N

njoracle

I plan to make a loan to one of my kids and charge them interest based
on the Primary market rate, currently about 3.25%. I use the Primary
rate because that is what I have to pay on my Home Equity Loan to get
the money for the kid.

I understand the IRS wants me to report interest income based on the
"Federal Rate". What is the Federal Rate? If I report the actual income
received from the kid which will be linked to the Primary market rate,
is that higher than the "Federal Rate"? If it is, then I presume I have
no problem and just need to enter the actual interest received somewhere
on one of my tax forms.
 
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A

Alan

I plan to make a loan to one of my kids and charge them interest based
on the Primary market rate, currently about 3.25%. I use the Primary
rate because that is what I have to pay on my Home Equity Loan to get
the money for the kid.

I understand the IRS wants me to report interest income based on the
"Federal Rate". What is the Federal Rate? If I report the actual income
received from the kid which will be linked to the Primary market rate,
is that higher than the "Federal Rate"? If it is, then I presume I have
no problem and just need to enter the actual interest received somewhere
on one of my tax forms.
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:
http://www.irs.gov/app/picklist/list/federalRates.html
There 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.
http://www.fool.com/taxes/2002/taxes020816.htm
 
S

Salmon Egg

Alan <[email protected]> said:
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:
http://www.irs.gov/app/picklist/list/federalRates.html
There 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.
http://www.fool.com/taxes/2002/taxes020816.htm
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.

--

Sam

Conservatives are against Darwinism but for natural selection.
Liberals are for Darwinism but totally against any selection.
 
T

Tempuser

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

RogerT

njoracle said:
I plan to make a loan to one of my kids and charge them interest based
on the Primary market rate, currently about 3.25%. I use the Primary
rate because that is what I have to pay on my Home Equity Loan to get
the money for the kid.

I understand the IRS wants me to report interest income based on the
"Federal Rate". What is the Federal Rate? If I report the actual
income received from the kid which will be linked to the Primary
market rate, is that higher than the "Federal Rate"? If it is, then I
presume I have no problem and just need to enter the actual interest
received somewhere on one of my tax forms.
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?
 
S

Stuart A. Bronstein

RogerT said:
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?
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.
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.
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.
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?
It's certainly legal. There are tax consequences, though.
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?
Yes, as stated above.
 
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S

Salmon Egg

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.
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.
[/QUOTE]

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

--

Sam

Conservatives are against Darwinism but for natural selection.
Liberals are for Darwinism but totally against any selection.
 
N

njoracle

Alan said:
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:
http://www.irs.gov/app/picklist/list/federalRates.html
There 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.
Thanks for the reply. The loan will be greater than $10K but limited to
5 years so I should be okay using 3.25%
 
R

RogerT

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.
Yes, as stated above.
Thanks Stuart.
 
S

Steve Pope

RogerT said:
Stuart A. Bronstein wrote:


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
 
S

Stuart A. Bronstein

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.
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.
 
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T

Tom Healy CPA

I plan to make a loan to one of my kids and charge them interest based
on the Primary market rate, currently about 3.25%. I use the Primary
rate because that is what I have to pay on my Home Equity Loan to get
the money for the kid.

I understand the IRS wants me to report interest income based on the
"Federal Rate". What is the Federal Rate? If I report the actual income
received from the kid which will be linked to the Primary market rate,
is that higher than the "Federal Rate"? If it is, then I presume I have
no problem and just need to enter the actual interest received somewhere
on one of my tax forms.
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).
 
N

njoracle

Tom said:
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.
 
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B

Bill Brown

I plan to make a loan to one of my kids and charge them interest based
on the Primary market rate, currently about 3.25%. I use the Primary
rate because that is what I have to pay on my Home Equity Loan to get
the money for the kid.

I understand the IRS wants me to report interest income based on the
"Federal Rate". What is the Federal Rate? If I report the actual income
received from the kid which will be linked to the Primary market rate,
is that higher than the "Federal Rate"? If it is, then I presume I have
no problem and just need to enter the actual interest received somewhere
on one of my tax forms.
The specific rules depend upon the amount of the loan.
 

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