Intra-Family Loans and the Applicable Federal Rate

A loan is not a gift

A genuine loan is not a gift: the borrower is obligated to repay, so nothing has been given away. That makes an intra-family loan a useful way to help a relative without using any annual exclusion or lifetime exemption. But the tax law will only respect it as a loan if it looks like one — a real obligation to repay, and, crucially, adequate interest. Charge too little, and the IRS treats the shortfall as a gift after all, under the below-market-loan rules of IRC § 7872.

The applicable federal rate

“Adequate interest” has a precise floor: the applicable federal rate, or AFR. The IRS publishes AFRs every month in a revenue ruling, in three tiers by loan length — short-term (up to 3 years), mid-term (over 3 up to 9 years), and long-term (over 9 years) — derived from average market yields on Treasury securities (IRC § 1274(d)). Charge at least the AFR for the loan’s term in the month it is made, and the loan carries adequate interest; no gift arises from the interest rate.

What happens if you charge too little

If the loan charges less than the AFR, § 7872 recharacterizes the arrangement. For a “gift loan” between family members, the law treats the lender as having made a gift of the forgone interest to the borrower each year, and simultaneously as having received that interest back as taxable income — even though no cash changed hands. So an interest-free loan to a relative can quietly generate an annual gift (measured by the interest you didn’t charge) and phantom interest income to you. Charging the AFR avoids both.

The $10,000 and $100,000 rules

Two statutory thresholds soften the rule for smaller family loans:

• The $10,000 de minimis exception. The below-market rules generally do not apply to gift loans between individuals whose total outstanding balance stays at or under $10,000 — provided the loan is not used to buy income-producing property (IRC § 7872(c)(2)). Small family loans usually fall outside the rules entirely.
• The $100,000 limit on imputed income. For gift loans between individuals of $100,000 or less, the amount of interest income imputed back to the lender is capped at the borrower’s net investment income for the year — and is treated as zero if that income is $1,000 or less (§ 7872(d)(1)). This limits the income-tax side of a modest loan even when some interest is imputed.

These figures are fixed by statute and are not inflation-indexed, so the same $10,000 and $100,000 thresholds have applied for years.

Making it a real loan

To be respected, an intra-family loan should look like an arm’s-length one: a written promissory note stating the amount, an interest rate at least equal to the AFR for the term, a repayment schedule, and an actual pattern of repayment. Forgiving payments as you go can turn the “loan” into a gift and, if done from the start, can suggest there was never an intent to be repaid — which would make the whole transfer a gift. Used properly, though, the intra-family loan is a clean tool: it can help a family member at a rate far below a commercial lender’s while spending none of your exclusion, and it underlies more advanced techniques such as sales to grantor trusts. How it compares with an outright gift is the subject of the gifting-versus-inheriting page.

Sources & methodology