It can be a tricky business lending money to friends and relatives in many instances; and not just because of the stress it can place on your relationships. Tax issues are involved as well. Today, we at Mark Dicus & Company would like to offer some suggestions in the event you have to lend money to someone close to you, particularly regarding the tax code.
How Much Interest Should I Charge a Friend or Family for a Loan?
Even to friends and family, yes, you definitely need to charge interest. The IRS will imply interest in the loan and tax you for the interest they assume you should be getting in the event you do not charge a minimum rate. If you are not actually getting a dime, this can occur. The amount must be reasonable in the eyes of the IRS in addition to charging interest. The IRS will imply interest at their minimum applicable federal rates (AFRs) if not. Being available on the IRS website, the always charge an interest rate at or above these AFRs to be on the safe side. Those interest rates are low and almost always below the prime interest rate which is good news.
Interest Free Loans to Family & Friends
Many people simply do not want to charge interest for to their family. While not every situation offers exceptions, there are two for you to take note of:
1) Gift the money. This maximum remains $15,000 in 2019 as you and your spouse can each give up to $15,000 to an individual each year.
2) Offer a loan less than $10,000. The only stipulation is that it cannot be used to purchase income-producing property. Special tax rules apply if you do not charge interest and the loan is used to purchase income-producing property like capital equipment or to acquire a business. It is good to ask for assistance in this case.
Write the Loan Agreement
Write out the terms of your loan if you expect repayment. You can use the many of basic loan document formats online to get your loan in writing. When dealing with a friend or family member, creating a loan document may seem unnecessarily formal, and they are the important 2 reasons below.
1) Tax code compliance spelled out in the documents. You can clearly show you are within tax code rules, by documenting the terms and charging a stated interest rate.
2) Avoid the misunderstanding. To make it clear that it is a real loan, not an informal gift, creating a written document will do so. When you expect repayment and that you expect to be paid back will be known to your friend or relative.