Forgiving a Family Loan: When Forgiveness Is a Gift

Is forgiving a loan to a family member a gift?

Yes. The gift tax applies to direct and indirect transfers (IRC § 2511), and the regulations name “the forgiving of a debt” as one way a taxable transfer is made (Treas. Reg. § 25.2511-1(a)). The amount forgiven counts with your other gifts to that person against the annual exclusion: $19,000 for 2026 (Rev. Proc. 2025-32) and $20,000 for 2027 (Rev. Proc. 2026-35). Anything above it is reported on Form 709 and applied against your lifetime exemption.

The borrower generally has no taxable income when a debt is canceled as a gift (IRS Publication 4681).

The amount of the gift and the annual exclusion

The gift tax is imposed on transfers of property by gift during the calendar year (IRC § 2501), so each act of forgiveness is counted in the year it happens. The gift is the amount of debt released. The regulations presume a note is worth its unpaid principal plus accrued interest unless a lower value is established (Treas. Reg. § 25.2512-4), so cancelling unpaid interest along with principal adds to the total.

Forgiveness shares the exclusion with everything else given to the same person that year, including any interest deemed given under the below-market loan rules. Married lenders can elect to treat a gift as made half by each (IRC § 2513); see the gift-splitting page. The exclusion and the exemption are explained on the annual-exclusion and lifetime-exemption pages.

Forgiveness planned from the start

Forgiving part of a real loan each year is different from making a “loan” that was never meant to be collected. The IRS’s published position is Rev. Rul. 77-299, 1977-2 C.B. 343. As the IRS has since restated it, in general, if a person makes a loan and, as part of a prearranged plan, intends to forgive or not collect on the note, the note is not treated as valuable consideration and the lender has made a gift of the full amount at the time of the loan.

The practical difference is timing and size. A lender who intended repayment and later forgives has made a gift when the forgiveness happens, in the amount forgiven. Under the IRS’s position, a lender with a plan from the outset to cancel each payment as it falls due has given the whole principal in the year of the loan, with that one year’s annual exclusion to set against it.

The restatement described above appears in IRS Private Letter Ruling 200603002. A private letter ruling is directed only to the taxpayer who requested it and may not be used or cited as precedent; it is linked here as the IRS’s own summary of the revenue ruling. What makes a loan genuine in the first place is covered on the intra-family loans page.

Income tax for the borrower

Canceled debt is ordinarily income to the person who owed it: gross income includes “income from discharge of indebtedness” (IRC § 61(a)(11)). Gifts are the exception. Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance (IRC § 102(a)), and the IRS applies that to canceled debt:

• Publication 4681 says that in most cases there is no income from canceled debt if the debt is canceled as a gift, bequest, devise, or inheritance.
• IRS Tax Topic 431 lists amounts canceled as gifts, bequests, devises, or inheritances among the exceptions to taxable cancellation-of-debt income.

The exception depends on the cancellation being a gift. A debt written off for a commercial reason, such as a settlement for less than the balance, is outside it.

Income tax for the lender

For a lender who lent cash, forgiveness is a gift, not a sale. A different rule applies to a note received for selling property on the installment method. Under IRC § 453B(f), an installment obligation that is canceled is treated as disposed of other than by sale or exchange, so the seller recognizes the difference between the obligation’s fair market value and its basis (§ 453B(a)). When the buyer and seller are related persons, that fair market value is treated as not less than the face amount.

In plain terms, a parent who sold a house or a business interest to a child for an installment note and then cancels the note has to recognize the gain that was being deferred, in addition to making a gift.

Forgiving the loan in a will

A lender can leave the debt in place and cancel it by will. That is a bequest, not a lifetime gift, and the two are taxed under different systems.

Sources: IRC § 2033, § 2501, and § 2503(b); Treas. Reg. § 20.2031-4 and § 25.2511-1(a); IRS Publication 4681.

For an installment note, § 453B does not apply to a transmission at death except as provided in § 691 (§ 453B(c)). What happens to the deferred gain when a note is cancelled at death is governed by § 691, which this page does not cover.

Form 709 and records

The Form 709 instructions list forgiving a debt among the transactions the gift tax may apply to. When the amount forgiven, added to other gifts to the same person for the year, exceeds the annual exclusion, the lender files Form 709, generally by April 15 of the following year. The return is covered on the Form 709 page.

Keep the note, the payment history, and a dated written statement of each forgiveness. Those records show that the debt was real, that payments were expected, and when and how much was released, which are the facts that separate a later gift from a transfer treated as a gift at the outset.

Sources