What the IRS says about family loans

Lend a meaningful amount to someone you love and the IRS may take an interest, even though no bank is involved. Here is how the rules actually work: below-market loans, the AFR, imputed interest, and the gift tax, in plain English.

The short version

The IRS mostly cares about two things when family members lend money. First, that a real loan is not secretly a gift, because large gifts have their own tax rules. Second, that a lender is not skipping interest income by charging nothing on a big loan. Small loans between people rarely raise either issue. Larger ones can, and the common fix is simple: charge at least the government's published minimum rate, write everything down, and keep a record of the payments.

Everything below unpacks how that works.

Loan or gift: why the label matters

When money moves between relatives, the IRS wants to know which one it was. A gift can count against the giver's gift tax limits and may require a gift tax return. A loan does not, but only if it actually behaves like a loan: there is a real expectation of repayment, and repayment actually happens.

If a "loan" has no paperwork, no interest, no schedule, and no payments, the IRS can decide it was a gift all along. That is not a technicality. It changes whose taxes are affected and how. People who want the loan treatment generally make sure the record supports it, which is the whole point of documenting the loan properly. Our guide on loans versus gifts goes deeper on this distinction.

Below-market loans and imputed interest

Here is the core concept behind most of the IRS rules in this area. If you lend a large amount at zero interest, or at a rate below the government's published minimum, the tax code can treat it as a "below-market loan." When that happens, the IRS pretends the missing interest was charged anyway.

Picture a sister lending her brother a large sum at zero percent. The tax code's fiction runs like this: the brother is treated as if he paid market-rate interest, the sister is treated as if she received that interest as income, and then she is treated as if she gave the same amount right back to him as a gift. Nothing actually changed hands. But the sister can owe income tax on interest she never collected, and the phantom gift can count toward her gift tax limits.

That invented interest is called imputed interest. It exists so people cannot move large amounts of wealth around, tax free, by dressing gifts up as interest-free loans.

The AFR: the government's minimum rate

So what counts as "below market"? The IRS answers that question every month by publishing the Applicable Federal Rates, usually shortened to AFR. There are three main flavors based on the length of the loan: short-term for loans of three years or less, mid-term for loans over three and up to nine years, and long-term for anything longer.

If a family loan charges at least the AFR for its term, the imputed interest rules generally stay out of the picture. And here is the pleasant surprise: the AFR is usually well below what a bank would charge. A family loan at the AFR can be a genuinely good deal for both sides, with the borrower paying less than a bank rate and the lender earning more than a savings account.

You can find the current rates on the IRS site at https://www.irs.gov/applicable-federal-rates. A common approach is to look up the AFR for the month the loan begins, write that exact rate into the loan agreement, and keep a copy of where it came from. Our guide on choosing an interest rate for a family loan walks through this in more detail.

The size tiers people talk about

Not every family loan is big enough for these rules to matter. The tax code sets out size thresholds that shape how the below-market rules apply. Two numbers come up constantly in this conversation: $10,000 and $100,000. Both come from the statute rather than annual inflation adjustments, but the details around them have exceptions and conditions, so treat this table as a map, not the law itself.

The annual gift tax exclusion

The gift tax shows up in family lending more often than people expect, so it helps to know the basic shape of it. Each year, you can give any one person up to a set amount without needing to file a gift tax return. That amount is indexed and changes over time, so rather than quote a number that may be stale by the time you read this, check the IRS's own page: frequently asked questions on gift taxes.

Two reassuring details. Going over the annual exclusion usually does not mean tax is owed right away. It typically means the giver files a form and the excess counts against a much larger lifetime exemption. And gifts between spouses who are both US citizens generally are not limited at all.

Why does this matter for loans? Because when a loan gets reclassified as a gift, or when imputed interest creates a phantom gift, this is the framework the amounts get measured against.

Forgiving a loan can create a gift

Family loans sometimes end with grace instead of a final payment. A parent decides the last chunk does not need to come back. A sibling says forget it after a rough year. That generosity has a tax shape: when a lender forgives part or all of a loan balance, the forgiven amount is generally treated as a gift in the year it is forgiven.

Some families lean into this on purpose, forgiving a slice of a large loan each year in a way that fits within the annual exclusion. That can be a legitimate approach, but it sits close to a line the IRS watches: a loan that was never really meant to be repaid can be treated as a gift from day one. This is exactly the kind of plan people run past a tax professional before starting, not after.

If the IRS ever asks: what a real loan looks like

Suppose the question ever comes up, in an audit or in settling an estate: was that money a loan or a gift? The IRS does not read minds. It reads records. The factors that tend to matter look like this:

• A written, signed loan agreement or promissory note
• A stated interest rate, often at least the AFR for larger loans
• A fixed repayment schedule with real due dates
• Payments that actually happened, on the record
• A borrower who could plausibly repay when the loan was made
• A lender who followed up when payments slipped

A loan that lives only in memory and group texts checks none of these boxes. A loan with a signed agreement and a clean payment history checks nearly all of them. This is where documentation stops being paperwork and starts being protection, for the relationship and for the tax story.

This is also the specific problem Kinlend exists to solve. Kinlend is not a lender, and no money moves through it. It is a documentation and tracking tool for loans between people who trust each other: an e-signed loan agreement, a payment schedule, payment tracking where both sides confirm each payment, and gentle reminders, on the web and on iPhone. Plans from $0.99 per month unlock e-sign and tracking. The result is the kind of dated, two-sided record that makes "it was a loan" easy to show. Our guide to the family loan agreement covers what belongs in the document itself.

What many families actually do

Pulling it together, a common playbook for a larger family loan looks like this. Look up the current AFR for the loan's length and write that rate, or something above it, into the agreement. Put the terms in a signed document with a real repayment schedule. Track every payment as it happens. If forgiveness ever enters the picture, treat it as the tax event it is and get advice first. And for smaller loans, relax a little: the rules were built with large transfers of wealth in mind, not the $2,000 that got a nephew through a hard month.

None of that is complicated. It just has to actually get done, which is easier when the agreement, the schedule, and the payment history all live in one place.