Loans to Family Members

Loaning money to family members may seem like a good idea as it will save on bank fees, and a close relative may offer the best interest rate. Be aware of the implications should you decide to do this. The IRS can carefully scrutinize loans between private individuals. It is best to document all of the relevant features of the loan including the amount, the interest rate, the terms of repayment, and a description of the collateral if applicable. The interest rate must be in consonance with current market rates.

No-interest or low interest loans could mean trouble for the lender. The lender is assumed to be earning a minimum amount of interest and will owe tax on the “imputed interest” whether or not the interest is actually collected. 

In order for the interest expense to be deductible for the borrower, the loan must be secured by real estate and the mortgage note recorded at the registry of deeds or county seat. A loan to a business does not require recording at the registry.

Interest income received by the lender is reported on Schedule B of his/her tax return.