Low rate on family loan can trigger gift tax
Dear Dr. Don,
I plan to lend a family member a sum of $30,000 and need to know what interest rate I should be charging him. He will be paying the loan back within six months.
-- Bank of Briana
It's really up to you what rate to charge him. If the rate is below the applicable federal rate, or AFR, the reduction in interest expense is considered a gift. An earlier column, "Family loan raises crucial tax issues," talks you through the AFR and gift tax issues.
Regardless of how close the family member is, I think you need to seal the deal with more than a handshake. Document the loan terms, including interest, and establish what recourse you have if the payments aren't made as planned. The Bankrate feature "Lending to friend? Charge interest" has a link to blank promissory note forms.
Given the short-term nature of the loan, it's up to you whether to receive monthly payments or a lump sum at the end of the loan. You can use Bankrate's Interest-only loan payment calculator to calculate the monthly interest payment.
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