What happens if I lend money to my child at no interest?
Under IRC § 7872, the interest you did not charge is treated as transferred from you to your child — a gift — and then paid back to you as interest, which is income to you. The amount is measured against the applicable federal rate. The rule does not apply on any day the total loans between the two of you are $10,000 or less, unless the money is used to buy or carry income-producing assets (§ 7872(c)(2)).
For loans of $100,000 or less, the interest income imputed to you is capped at your child’s net investment income, and treated as zero if that income is $1,000 or less (§ 7872(d)(1)). These dollar amounts are written into the statute.
What counts as a below-market loan
Section 7872(e) and (f) define the terms that drive the calculation:
- Demand loan. A loan payable in full at any time on the lender’s demand. It is below-market if interest is payable at less than the applicable federal rate.
- Term loan. Any loan that is not a demand loan. It is below-market if the amount loaned exceeds the present value of all payments due under the loan, discounted at the applicable federal rate.
- Gift loan. A below-market loan where the forgoing of interest is in the nature of a gift.
- Applicable federal rate. For a demand loan, the federal short-term rate in effect for the period being measured. For a term loan, the rate for the loan’s term in effect on the day the loan was made. Both are compounded semiannually.
A husband and wife are treated as one person under the section (§ 7872(f)(7)). The rates themselves are explained on the applicable federal rate page and published monthly by the IRS at irs.gov/applicable-federal-rates.
Demand loans: forgone interest each year
For a gift loan payable on demand, § 7872(a) uses forgone interest: the interest that would have been payable if it accrued at the applicable federal rate, minus any interest actually payable. That amount is treated as transferred from lender to borrower and retransferred from borrower to lender as interest. Both steps are treated as happening on the last day of the calendar year.
The deemed gift counts with the lender’s other gifts to the same person for the year when measured against the annual exclusion, which is $19,000 for 2026 (Rev. Proc. 2025-32).
Term loans: two calculations for one loan
A gift loan with a fixed term is measured differently for gift tax and for income tax.
- Gift tax. Section 7872(d)(2) applies subsection (b)(1): the lender is treated as transferring, on the date the loan is made, the amount loaned minus the present value of all required payments. The whole gift falls in the first year.
- Income tax. Subsection (a) still applies, so forgone interest is treated as paid to the lender year by year while the loan is outstanding.
The $10,000 and $100,000 rules
Three fixed dollar amounts in § 7872 limit the rule for gift loans made directly between individuals. They do different jobs.
| Statutory amount | Effect | Where it stops applying |
|---|---|---|
| $10,000 — § 7872(c)(2) | Section 7872 does not apply on any day the total outstanding loans between the two individuals are $10,000 or less. No deemed gift and no imputed income for that day. | A gift loan directly attributable to buying or carrying income-producing assets. |
| $100,000 — § 7872(d)(1) | For income tax, the amount treated as paid back to the lender as interest for the year cannot exceed the borrower’s net investment income for that year. | Any day total outstanding loans between lender and borrower exceed $100,000, and any loan with tax avoidance as a principal purpose of the interest arrangement. |
| $1,000 — § 7872(d)(1)(E)(ii) | If the borrower’s net investment income for the year is $1,000 or less, it is treated as zero, so no interest is imputed to the lender under the $100,000 rule. | The same limits as the $100,000 rule. |
Source: IRC § 7872(c)(2) and (d)(1). The amounts are fixed in the statute text.
The $100,000 rule is written “for purposes of subtitle A”, the income tax. It limits the lender’s imputed interest income; it does not reduce the deemed gift. A hypothetical example: an $80,000 interest-free demand loan outstanding all year, at the same illustrative 4% rate, has forgone interest of $80,000 × 0.0404 = $3,232. If the borrower has $700 of net investment income, the lender reports no imputed interest. If the borrower has $2,000, the lender reports $2,000. The gift is $3,232 in both cases.
Net investment income takes its meaning from IRC § 163(d)(4), and a borrower with more than one gift loan allocates it among them. For a term loan, once § 7872 has applied on any day it keeps applying even if the balance later drops to $10,000 or less; for a gift loan that carry-forward applies for gift-tax purposes only (§ 7872(f)(10)).
Loans that are not gift loans
Section 7872 also reaches compensation-related loans between employer and employee, loans between a corporation and a shareholder, and loans with tax avoidance as a principal purpose (§ 7872(c)(1)). A term loan in those categories is treated under subsection (b): the lender is treated as transferring the discount to the borrower in cash on the day of the loan, and the loan is treated as having original issue discount in the same amount. That original issue discount treatment does not apply to a gift loan for income-tax purposes, which is why a family term loan has the two calculations described above.
Reporting, and how to stay outside the rules
The lender reports the imputed amount as interest income, and the borrower may be able to deduct it if the loan proceeds are used for business or investment (IRS Publication 550). The Form 709 instructions list making an interest-free or below-market loan among the transactions the gift tax may apply to, so a deemed gift that takes the lender over the annual exclusion for that borrower is reported on a gift-tax return.
A loan that charges at least the applicable federal rate for its term is not a below-market loan, and none of this arithmetic applies. Setting up a loan that way, with a note and a repayment record, is covered on the intra-family loans page. Cancelling the principal later is a separate gift, covered on the forgiving a family loan page.
Sources
Methodology & sources
Primary sources are cited in place: IRC § 7872 (subsections (a) through (f)) and § 163(d)(4), from the official U.S. Code published by the U.S. House Office of the Law Revision Counsel; IRS Publication 550; the IRS Instructions for Form 709; and Rev. Proc. 2025-32 for the 2026 annual exclusion. The $10,000, $100,000, and $1,000 amounts are fixed in § 7872. The 4% rate in the examples is illustrative and is not a published rate; current rates are at irs.gov/applicable-federal-rates. See our editorial standards.
This information is educational and is not legal or tax advice. The examples simplify the calculation, and the result for an actual loan depends on its terms, dates, and the rates in effect; confirm yours with a qualified tax professional.
Last verified November 13, 2026.