| Feature | Intrafamily Loan | Financial Gift |
|---|---|---|
| Repayment | Set repayment plan | No repayment |
| Yearly Limit | None | $19,000 for singles, $38,000 for married couples |
| Tax Consequences for Lender/Giver | Must charge the borrower at least the Applicable Federal Rate for loans over $10,000 and report interest income | None if under the yearly limit; if it exceeds that, it must be reported and goes toward the lifetime exemption |
| Tax Consequences for Borrower/Recipient | Tax-free, but must be repaid to lender | Tax-free, with no repayment |
Loan vs. gift
For the down payment to qualify as an intrafamily loan, you must have a repayment plan in place and a written loan contract, and you must pay interest on the funds. Ideally, the rate should meet or exceed the Applicable Federal Rate (AFR) set by the government. Establish a paper trail that documents the repayment plan and interest rate. You can do so via a promissory note or any other formal contract.
If you don’t create a paper trail that establishes all the requirements listed above, the IRS could view the loan as a gift. Similarly, if the loan charges little or no interest, the government could treat the waived interest as taxable income or a gift. If the IRS classifies the funds as a gift, the giver may owe gift tax if the waived interest exceeds the annual exclusion. Currently, that exclusion is $19,000 per recipient for singles and $38,000 per recipient for married couples.
Tax and deductions to borrower
There is typically no tax to the borrower if funds are provided as a loan. You can deduct interest paid on intrafamily loans if the loan goes toward the mortgage on your main home.
Tax to family lender
With intrafamily loans, the family lender must report interest income to the IRS. The interest must be treated as taxable income on their tax return.
If the funds provided qualify as a gift, the giver will need to report it to the IRS if it exceeds the annual gift tax exclusion: $19,000 per recipient for singles and $38,000 per recipient for couples. Use Form 709 to report the gift to the IRS.
Below-market, interest-free loan rules
If the loan exceeds $10,000 and the interest is less than the IRS Applicable Federal Rate (AFR) for loans, the IRS may “impute” interest. In that case, the IRS may treat the difference between the AFR and the rate charged as a taxable gift. If that forgone interest amount exceeds the annual gift tax exclusion, it may be necessary to report it as a gift to the IRS using Form 709.
What is a gift letter?
A mortgage gift letter is a document establishing the source of a borrower’s down payment. This letter proves that the person providing the funds is offering a gift and does not expect repayment. Lenders may want to see a gift letter when deciding whether you can afford the mortgage loan. If the funds you receive to pay your down payment are not a gift, they count as additional debt, and that affects your debt-to-income ratio. Mortgage lenders look at that ratio when deciding how much money they’re willing to lend you.
If a loan is forgiven later
If a family member loans you money and later forgives the debt, they must report the event to the IRS by filing Form 1099-C. Note that filing this form is only necessary in cases where the debt exceeds $600.
